Using Option Straddle Strategies
Investors who wish to trade both calls and puts together for the purpose of taking advantage of a stock's volatility – or lack thereof - could use what is known as an option straddle strategy in order to accomplish this. A straddle strategy is based on either purchasing or selling both a call and a put of a particular stock. Thus, there are both long straddle strategies as well as short straddle strategies.
Long Straddle Strategy
The long straddle strategy is typically used when an investor believes that the price of a stock will move significantly, however, they are unsure of whether that price movement will be up or down. In any case, however, the stock must make a significant move in one direction or the other in order for the investor to profit. And conversely, should the stock only move in a small direction one way or the other, then the investor will experience a loss.
To initiate a long straddle strategy, the investor would buy both a call and a put of a specific stock. In this case, both the call and the put will have the same expiration date as well as the same strike price.
Short Straddle Strategy
An investor using a short straddle strategy is hoping for just the opposite of a long straddle strategy investor to occur on the movement of the price of the underlying stock. This investor will sell both a call and a put on the same stock in hopes that the market has little or no movement.
If the market on that particular stock remains stable, or at least shows very little movement either up or down, then the options of the call and the put will expire and the investor will have made a profit.
Short straddle strategies tend to carry more risk than long straddle strategies. This is because the investor will essentially have obligations on both sides of the market. Therefore, the only way that an investor using a short straddle strategy will make a profit is if both the call and the put option last through to their expiration date and expire. The only other way for an investor to profit with this short strategy is if they are able to close out both the call and the put by trading them lower than where they sold the options short.
Investors who are more advanced may be able to create other variations of straddle strategies. This may be accomplished by purchasing different amounts of calls and puts with differing strike prices or expiration dates. Often this can help the investor to modify the straddles to more closely fit their specific investment strategy and risk tolerance.
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