Important legal information about the email you will be sending. By using this service, you agree to input your real email address and only send it to people you know.
It is a violation of law in some jurisdictions to falsely identify yourself in an email. All information you provide will be used by Fidelity solely for the purpose of sending the email on your behalf. The subject line of the email you send will be "Fidelity. A long straddle consists of one long call and one long put. Both options have the same underlying stock, the same strike price and the same expiration date. A long straddle is established for a net debit or net cost and profits if the underlying stock rises above the upper break-even point or falls below the lower break-even point.
Profit potential is unlimited on the upside and substantial on the downside. Potential loss is limited to the total cost of the straddle plus commissions. Profit potential is unlimited on the upside, because the stock price can rise indefinitely. On the downside, profit potential is substantial, because the stock price can fall to zero.
Potential loss is limited to the total cost of the straddle plus commissions, and a loss of this amount is realized if the position is held to expiration and both options expire worthless.
Both options will expire worthless if the stock price is exactly equal to the strike price at expiration. A long straddle profits when the price of the underlying stock rises above the upper breakeven point or falls below the lower breakeven point. A long — or purchased — straddle is the strategy of choice when the forecast is for a big stock price change but the direction of the change is uncertain. Straddles are often purchased before earnings reports, before new product introductions and before FDA announcements.
The risk is that the announcement does not cause a significant change in stock price and, as a result, both the call price and put price decrease as traders sell both options. It is important to remember that the prices of calls and puts — and therefore the prices of straddles — contain the consensus opinion of options market participants as to how much the stock price will move prior to expiration.
The same logic applies to options prices before earnings reports and other such announcements. Dates of announcements of important information are generally publicized in advanced and well-known in the marketplace. Furthermore, such announcements are likely, but not guaranteed, to cause the stock price to change dramatically.
As a result, prices of calls, puts and straddles frequently rise prior to such announcements. An increase in implied volatility increases the risk of trading options. Buyers of options have to pay higher prices and therefore risk more. For buyers of straddles, higher options prices mean that breakeven points are farther apart and that the underlying stock price has to move further to achieve breakeven.
Sellers of straddles also face increased risk, because higher volatility means that there is a greater probability of a big stock price change and, therefore, a greater probability that an option seller will incur a loss. This means that buying a straddle, like all trading decisions, is subjective and requires good timing for both the buy decision and the sell decision.
When the stock price is at or near the strike price of the straddle, the positive delta of the call and negative delta of the put very nearly offset each other. Thus, for small changes in stock price near the strike price, the price of a straddle does not change very much. This happens because, as the stock price rises, the call rises in price more than the put falls in price. Also, as the stock price falls, the put rises in price more than the call falls. Positive gamma means that the delta of a position changes in the same direction as the change in price of the underlying stock.
As the stock price rises, the net delta of a straddle becomes more and more positive, because the delta of the long call becomes more and more positive and the delta of the put goes to zero. Similarly, as the stock price falls, the net delta of a straddle becomes more and more negative, because the delta of the long put becomes more and more negative and the delta of the call goes to zero.
Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices — and straddle prices — tend to rise if other factors such as stock price and time to expiration remain constant. Therefore, when volatility increases, long straddles increase in price and make money. When volatility falls, long straddles decrease in price and lose money.
This is known as time erosion, or time decay. Since long straddles consist of two long options, the sensitivity to time erosion is higher than for single-option positions. Long straddles tend to lose money rapidly as time passes and the stock price does not change. Owners of options have control over when an option is exercised. Since a long straddle consists of one long, or owned, call and one long put, there is no risk of early assignment. There are three possible outcomes at expiration.
The stock price can be at the strike price of a long straddle, above it or below it. If the stock price is at the strike price of a long straddle at expiration, then both the call and the put expire worthless and no stock position is created.
If the stock price is above the strike price at expiration, the put expires worthless, the long call is exercised, stock is purchased at the strike price and a long stock position is created. If a long stock position is not wanted, the call must be sold prior to expiration. If the stock price is below the strike price at expiration, the call expires worthless, the long put is exercised, stock is sold at the strike price and a short stock position is created.
If a short stock position is not wanted, the put must be sold prior to expiration. Long straddles involve buying a call and put with the same strike price. For example, buy a Call and buy a Put. Long strangles, however, involve buying a call with a higher strike price and buying a put with a lower strike price.
For example, buy a Call and buy a 95 Put. There are three advantages and two disadvantages of a long straddle. The first advantage is that the breakeven points are closer together for a straddle than for a comparable strangle. Third, long straddles are less sensitive to time decay than long strangles.
Thus, when there is little or no stock price movement, a long straddle will experience a lower percentage loss over a given time period than a comparable strangle. The first disadvantage of a long straddle is that the cost and maximum risk of one straddle one call and one put are greater than for one strangle. Second, for a given amount of capital, fewer straddles can be purchased.
The long strangle two advantages and three disadvantages. The first advantage is that the cost and maximum risk of one strangle are lower than for one straddle. Second, for a given amount of capital, more strangles can be purchased.
The first disadvantage is that the breakeven points for a strangle are further apart than for a comparable straddle. Third, long strangles are more sensitive to time decay than long straddles. Thus, when there is little or no stock price movement, a long strangle will experience a greater percentage loss over a given time period than a comparable straddle. A long strangle consists of one long call with a higher strike price and one long put with a lower strike.
Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.
Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only. Skip to Main Content. Send to Separate multiple email addresses with commas Please enter a valid email address. Your email address Please enter a valid email address.
Goal To profit from a big price change — either up or down — in the underlying stock. Long 1 Call at 3. Related Strategies Long strangle A long strangle consists of one long call with a higher strike price and one long put with a lower strike.
Short straddle A short straddle consists of one short call and one short put. Please enter a valid ZIP code.More...