Long Straddle

Overview:

This term applies when an investor has purchased, or “gone long,” a straddle by simultaneously purchasing a call option and a put option with the same strike price and expiration date.  Investors purchasing a long straddle are expecting the underlying stock to make a large move in either direction. The investor in a long straddle benefits from either a large upwards move in the stock or a sharp decline move in the stock.

Main Uses:

There are many reasons why an investor would want to purchase a straddle.  Here are two of them:

1. The first reason an investor might use this strategy is to make an earnings play. Sometimes after a company makes an earnings announcement, the stock will experience a very large upswing or downswing, depending on the news and the market’s reaction to it.   By owning a straddle, the investor is betting that an earnings release will be a catalyst to make a stock move by more than the price of the straddle.
2. Another reason an investor might purchase straddles is to make a bet that implied volatilities will rise.  The idea behind this trade is that volatility is relatively cheap compared to historical volatility and it could increase, which would raise the price of a straddle.

Profit / Loss Long Straddle:

The below chart is a profit/loss graph of a long straddle built with the OptionsHouse P&L calculator, using HPQ as the ticker. With the stock trading at  $47.80, a 48-strike call is purchased for $2 and 48-strike put is purchased for $2.  The breakeven prices for this straddle are $44 to the downside (the strike price minus the premium paid) and $52 to the upside (the strike price plus the premium paid). If the stock price stays between $44 and $52, the investor will lose money.  If it moves outside that range, the investor will make money.  The maximum potential loss is limited to the premium of $4.00 paid (plus commissions). The maximum profit is theoretically unlimited to the upside and limited only by the zero mark to the downside.

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