Understanding the Long Straddle Strategy: A Comprehensive Guide

The long straddle strategy is a popular options trading strategy that traders use to capitalize on the significant price movements of an underlying security. This strategy involves buying both a call and a put option at the same strike price, with the goal of profiting from extreme price volatility.

What is a Long Straddle Strategy?

When executing a long straddle, traders simultaneously buy a call (buy) and a put (sell) option at the same strike price and with the same expiration date. The key idea behind this strategy is to take advantage of the volatility in the underlying asset, which could result in the price moving significantly higher or lower beyond the strike price.

How Does the Long Straddle Strategy Work?

The core concept of a long straddle is the simultaneous purchase of equal lots of a Call Option and Put Option with the same strike price. Here’s a step-by-step guide to understanding how it works:

Step 1: Identifying the Underlying Asset

The first step in executing a long straddle is to have a clear understanding of the underlying asset. This can be anything from an individual stock, like ITC, to a broader market index, such as Banknifty. For example, if ITC’s current market price is 180, and there is an expectation of significant price volatility due to upcoming quarterly earnings, a long straddle would be appropriate.

Step 2: Buying Call and Put Options

Once the underlying asset is identified, the trader buys a call option and a put option with the same strike price. These options are typically bought at around the at-the-money (ATM) strike price, which means the strike price is close to the current market price of the underlying asset.

Step 3: Managing Risk and Potential Reward

The risk and potential reward in a long straddle are both limited and unlimited, depending on the price movement of the underlying asset.

Total Risk: The total risk is limited to the total amount paid for the options, which is the sum of the call premium and the put premium.

Max Reward: The potential reward is unlimited, as the price of the underlying asset can move in any direction.

Upper Breakeven Point (UBEP): The upper breakeven point is calculated by adding the total premium to the call strike price.

Lower Breakeven Point (LBEP): The lower breakeven point is calculated by subtracting the total premium from the put strike price.

Example: Using a Long Straddle in a Volatile Scenario

Suppose the stock ITC is currently trading at 180, and in the next day, ITC will release its quarterly earnings. A long straddle would involve buying an ATM call option at 180 strike price for 5, and an ATM put option at 180 strike price for 5. Here's the pay-off chart for this strategy:

ITC Price Max Profit Kickout Strike Long Straddle Profit Loss 170 20 185,190 5 5 180 25 185,190 0 10 190 25 185,190 5 5

When to Use a Long Straddle Strategy

The long straddle strategy is particularly useful in scenarios where the underlying asset is likely to experience significant price volatility. This can be due to economic events, earnings reports, regulatory changes, or any other factors that might cause the underlying stock or index to move dramatically.

Key Characteristics of Long Straddle

The most suitable time to create a long straddle options strategy is when the premium is low. This ensures that the total cost of the options is as minimal as possible, allowing the trader to make the most of the potential price movements.

Where to Find Long Straddle Strategy

For those who want to implement the long straddle strategy but are unsure how to do it, there are several tools available online. Intraday Screener, for example, provides a robust options strategy builder that simplifies the process. Here's a step-by-step guide on how to use it:

Visit the options strategy builder in the Intraday Screener website. Select the indices and expiry date of the options contract you are interested in. Buy both the call and put options and click on 'add/edit' to get started. Select the 'Long straddle' strategy from the options available. Review the detailed information provided about the strategy, including the premium, maximum profit at expiry, maximum losses at expiry, and the breakeven points. Use the provided graph to visualize the potential outcomes of your long straddle strategy.

By following these steps, traders can effectively create a long straddle strategy and harness the power of options to capitalize on significant price movements in the underlying asset.