What are Straddles and Strangles?
A call option is the right to buy a given asset at a fixed price on or before a specific date. A put option is the right to sell a given asset at a fixed price on or before a specific date. Calls increase in value when the price of the underlying asset goes up; puts increase in value when the price of the underlying asset goes down. Straddles and strangles are options trading strategies that combine both puts and calls to create positions that do not depend on the direction of the market movement for their profitability. A long straddle position is constructed by purchasing both a put and a call at an exercise price at or near the current price of the underlying asset. To become profitable, the underlying must have a change in price greater than the total cost of the straddle, and the price change must occur prior to expiry. If it doesn’t, the straddle expires worthless. Since a straddle can never be worth less than zero, long straddles have limited risk and unlimited profit potential.
Simply put, Straddles and Strangles are strategies to use when you believe a stock will make a big move but are unsure of the direction. Specifically, a Straddle is long one call and long one put at the same strike price/expiration date on the same date. A Strangle is long one call at a higher strike price and long one put at a lower strike at the same expiration/same stock. One can also short Straddles and Strangles, however, this exposes the trader to unlimited downside risk and is only recommended to advanced option traders. Going long, as described above, has limited risk but unlimited profit potential. However, remember a move big enough to absorb the losing side is needed to profit, so these two strategies are only used when you expect a large move in one direction or the other. For example, let’s say that you believe ImClone will make a sharp move over the next several days, but are not certain of the move’s direction. A long Straddle would be buying a June 40 Put and buying a J
