Straddles Option Strategy

Buying a straddle is the simultaneous purchase of a call and a put of the same strike and expiration. An example of buying a straddle is the purchase of the May 100 call for $5 and the May 100 put for $5. This shows the profit potential in the present and at expiration of buying a straddle.

Recall the call and put buyer will each lose $5 if the future closes at 100 on expiration day. Therefore, the straddle buyer will lose $10 ($5 + $5) if the future settles at 100 at expiration. However, the straddle buyer will incur a profit if the future is below 90 or above 110 at expiration. Anyone buying a straddle expects the market to move either up or down by a large amount but will lose money if the market remains at the same price level.

Selling a straddle is the simultaneous sale of a call and a put of the same strike and expiration. Selling the June 100 call for $5 and the June 100 put for $5 is an example of selling a straddle.

The call and put seller will each make $5 if the future settles at 100 on expiration day, so the straddle seller will collect $10 if the future closes at 100 on expiration. The straddle seller will lose money if the market drops below 90 or rises above 110. Anyone selling a straddle expects the market to remain within a relatively narrow or well defined trading range but will lose money if the market moves considerably in either direction.

Debit and Credit

A debit transaction occurs when money is laid out or a net premium is paid. For example, buying the May 100 call and May 100 put straddle required a net outlay of cash of $10. Buying the September 100 call for $5 and selling the September 105 call for $3, for a net outlay of $2, is the same as buying the call spread for a $2 debit.

A credit transaction occurs when money is received or a net premium is taken in. For example, the seller of the May 100 call and May 100 put straddle will receive a $10 credit. The seller of the September 100-105 call spread (selling the September 100 call and buying the September 105 call) will receive a $2 credit.

Trades should not be done based on whether you can receive a credit or cheap debit, but instead on proper theoretical values of the options. This will be explored further in the options valuation section.