Long Straddle

Some option traders use a long straddle when they expect significant market volatility following a major event but unsure whether prices will sharply rise or fall.

Examples include announcements from the Federal Reserve, corporate earnings reports, or CPI data releases.

I. Strategy Explained

1) Setup

Buy Put + Buy Call

The underlying stock, strike price, expiration date, and contract quantity of the call and put options are all identical.

• If the stock price rises significantly, loss from the put option is generally offset by the profit from the call option, usually leading to an overall positive return.

• Conversely, if the stock price falls significantly, loss from the call option is generally offset by the profit from the put option, also usually resulting in an overall positive return.

2) Breakdown

The potential profit from a long straddle comes from simultaneously buying both put and call options. When the stock price falls, the put option price usually rises, and when the stock price rises, the call option price usually rises. If the total value of the strategy rises, the profit is realized when selling to close the position.

Whether the price goes up or down, as long as the magnitude of the move is large enough to offset the loss on one side with the profit on the other side, this strategy can be profitable.

3) Features of Strategy

Ideal conditions: Significant price rise or fall. This strategy may be appropriate when a significant stock price movement is expected, but the direction is uncertain.

Unlimited Profit: Because you are the buyer of both a call and a put, you can potentially profit regardless of whether the stock price rises or falls. The greater the magnitude of the price movement, the higher the potential profit. Profit is only unlimited on the call side because the maximum profit on the put side is reached if the stock price falls to zero.

Limited Loss: When the stock price equals the strike price, both options are out-of-the-money, resulting in a loss of the entire premium paid. Theoretical Maximum Loss = total premium paid.

Higher Initial Cost: You need to pay premiums for both options. At expiration, at least one of the options will be OTM and become worthless. Therefore, to potentially achieve a positive return, the stock's price movement must be significant.

Higher Volatility: This strategy tends to benefit from high volatility. If the underlying asset's price does not change significantly by the expiration date, you may lose the entire premium paid.

II. Case Study

The Federal Reserve will announce its interest rate decision this week, which is expected to trigger significant market volatility. You believe that TUTU's stock price will also fluctuate with the market, but you are uncertain whether it will rise or fall.

Currently, TUTU's stock price is $50. In anticipation of significant price movements next week, you buy both a call option and a put option with a strike price of $50, thereby constructing a long straddle strategy.

If the stock price rises sharply, the call option could generate profits. If the stock price falls sharply, the put option will generate profits. The greater the movement in either direction, the higher the potential returns.

Cost of purchasing the position:

Net premium from the put option: -$300 (-$3 paid per share).

Net premium from the call option: -$200 (-$2 paid per share).

Net premium in total: -$200 -$300=-$500 (-$5 paid per share).

1) Scenario 1: Stock price drops significantly

In this case, the call option is out-of-the-money, while the put option is in-the-money.

If you choose to exercise the put option, you can sell TUTU stock for $50. The greater the drop in the stock price, the higher the profit from exercising the Put option.

When the stock price drops by the amount of the total premium paid per share, which is $45 (calculated as the $50 strike price minus the $5 total premium paid per share), the position reaches its first breakeven. If the stock price continues to fall beyond this point, the strategy will yield higher positive returns.

You can also choose to close the position before expiration. When the stock price drops significantly, although the premium of the call option decreases, the premium of the put option will increase more. At this point, you can sell the entire portfolio at a higher price to achieve a positive return.

2) Scenario 2: Stock price rises significantly

In contrast to Scenario 1, in this case, the call option is in-the-money, while the put option is out-of-the-money.

If you choose to exercise the call option, you can buy TUTU stock, which is now priced higher, at $50. The greater the increase in the stock price, the higher the profit from exercising the call option.

When the stock price increases by the total premium paid per share, which is $55 (calculated as the $50 strike price plus the $5 total premium paid per share), the stock price reaches breakeven2. As the stock price continues to rise, this strategy will yield higher positive returns.

You can also choose to close the position before expiration. Similar to Scenario 1, when the stock price rises significantly, although the premium of the put option decreases, the premium of the call option will increase more. Therefore, this strategy maintains a positive return overall.

3) Scenario 3: Low stock price fluctuations

If the stock price fluctuates between breakeven1 and breakeven2, the profits from exercising the put or call options won't cover the cost of purchasing them, leading to a loss.

When the stock price equals the strike price, neither option yields any profit, and you lose the entire premium paid, resulting in the maximum loss of $500.

If you choose to close the position before expiration, the low fluctuations in the stock price will cause the value of the options to decay over time.

As a result, the premium received from selling the options will be less than the initial cost, leading to a loss.

III. How to construct a long straddle on moomoo

Scenario 1: Without the underlying position.

Access: Go to Options Chain > Tap on the Strategy tab at the bottom of the screen > Select Straddle

Choosing Buy, the system will then automatically help you buy one put option and buy one call option, forming a long straddle.

Scenario 2: Already hold one option.

Access: Go to Options Chain > Tap on the Strategy tab at the bottom of the screen > Select Single Options and directly buy a put option or a call option needed to complete the straddle. The option you own and the single option you purchase should be the same strike and expiration date and also be at or near the money.

IV. Applying the long straddle strategy

Core Strategy: Delta Neutral + Long Vega

Delta neutral means the strategy is neutral to market movements (rises or falls), while long Vega indicates an expectation of increased volatility, i.e., anticipating significant price fluctuations in the market, whether upward or downward.

This strategy is often used in scenarios where a significant event is expected to trigger substantial market volatility, especially when the specific direction of the price movement is unpredictable. By holding both call and put options, as long as the price movement is significant enough, profits can be made from a strong trend in either direction.

1) Earnings release

Financial reports can have a significant impact on a company's stock price. Whether the impact is positive or negative, it may lead to substantial price fluctuations.

By constructing a long straddle, investors only need to anticipate significant price movement without having to predict the price direction.

Common practice:

Construct a long straddle before the financial report (when implied volatility is generally low).

Exit the position decisively at the time of the financial report release (when IV is generally high).

2) Major macro/political events

Events such as the Federal Reserve's interest rate decisions, CPI releases, elections, and policy changes can also lead to significant market fluctuations.

Through a straddle options strategy, investors can invest in this potential volatility without needing to predict the specific direction of the impact.

3)Day trading

The long straddle strategy is also used in intraday trading. Typically, during certain periods, such as after the market opens or just before closes, market volatility tends to increase, making it difficult to predict stock price movements.

By constructing a long straddle strategy, traders seek to capture intraday price movements with minimal time value decay.

If market volatility is low, since intraday trades are typically closed within the same day, the potential loss from time decay is usually smaller than holding for a longer date.

If market volatility is high, investors that match this sentiment can potentially achieve gains.

V. FAQs

Q: Choosing a strike price

A: Most investors typically prefer to buy at-the-money (ATM) options, which have strike prices close to or equal to the current price of the underlying stock. The advantage of this approach is that the positive Delta of the call option and the negative Delta of the put option almost offset each other, making it Delta neutral.

Q: Choosing an expiration date

A: As this strategy is more appropriate for short-term speculation in response to market changes, most investors usually choose shorter expiration dates in order to reduce the impact of time value decay.

Q: If the position shows a gain, how can we realize profits?

A: When a long straddle strategy is already profitable on paper, it usually indicates that the stock price has experienced significant one-sided movement. You can choose to close the position early to lock in profits, rather than hold it until expiration. This approach helps to avoid further time value decay of options.

Q: If the position suffers loss, what measures can be taken?

A:

Method 1: Close the position

If IV is low, the value of call and put options will quickly diminish over time. To avoid losing the entire premium, you can consider incurring some losses and proactively close the position before the expiration date.

Method 2: Strategy adjustment

For some conservative investors, the strategy can be adjusted to a long iron butterfly by adding two legs: selling a call with a higher strike price and a put with a lower strike price.

By doing so, you would be reducing the initial cost of the trade but capping potential profits.

Method 3: Rollover

Close the current position, realize the loss and open the position of call and put with further expiration dates.

You can also adjust the strike prices through the rollover to match your investment objectives.