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					                                               STRADDLES                                    M-St - c040


Straddle: A trading position involving puts and calls on a one-to-one basis in which the puts and
calls have the same strike price, expiration and underlying stock. We buy At-The-Money strike puts
and ATM strike calls.

Later:
(Strangle: A trading position involving puts and calls on a one-to-one basis in which the puts and
calls have the same expiration and underlying stock but different strike prices. We buy Out-Of-The-
Money strike puts and OTM strike calls.)

Long straddle




An option payoff diagram for a long straddle position

A long straddle involves going long, i.e., purchasing, both a call option and a put option on some stock, interest
rate, index or other underlying. The two options are bought at the same strike price and expire at the same
time. The owner of a long straddle makes a profit if the underlying price moves a long way from the strike price,
either above or below. Thus, an investor may take a long straddle position if he thinks the market is highly
volatile, but does not know in which direction it is going to move. This position is a limited risk, since the most a
purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential. [1]

For example, company XYZ is set to release its quarterly financial results in two weeks. A trader believes that
the release of these results will cause a large movement in the price of XYZ's stock, but does not know
whether the price will go up or down. He can enter into a long straddle, where he gets a profit no matter which
way the price of XYZ stock moves, if the price changes enough either way. If the price goes up enough, he
uses the call option and ignores the put option. If the price goes down, he uses the put option and ignores the
call option. If the price does not change enough, he loses money, up to the total amount paid for the two
options. The risk is limited by the total premium paid for the options, as opposed to the short straddle where
the risk is virtually unlimited.

Short straddle
An option payoff diagram for a short straddle position

A short straddle is a non-directional options trading strategy that involves simultaneously selling a put and a
call of the same underlying security, strike price and expiration date. The profit is limited to the premiums of the
put and call, but it is risky because if the underlying security's price goes very high up or very low down, the
potential losses are virtually unlimited. The deal breaks even if the intrinsic value of the put or the call equals
the sum of the premiums of the put and call. This strategy is called "nondirectional" because the short straddle
profits when the underlying security changes little in price before the expiration of the straddle. The short
straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of
the premiums of the put and call.

A short straddle position is highly risky, because the potential loss is unlimited due to the sale of the call and
the put options which expose the investor to unlimited losses (on the call) or losses equal to the strike price (on
the put), whereas profitability is limited to the premium gained by the initial sale of the options. The Collar is a
more conservative "opposite" that limits gains and losses.

Straddle at-the-money
Technically, if you are buying a call and a put at the same price, you are buying a straddle. However, in
practice it is usual to buy a call and a put that are approximately at-the-money. This is because if, say, the
stock price is 85 and you are buying a straddle at 50, what you get is essentially a long position in the stock, so
you are not really betting on volatility.

Dellta-hedging a straddle
A straddle that is approximately at the money has delta that is close to zero. However, if the stock price moves
substantially up or down, then a straddle essentially becomes a short or a long position in the underlying
(stock). If the stock went up, then the side that is long the straddle would now prefer the stock to go higher up
(so it is essentially long the stock), while the side that is short the straddle would now prefer the stock to go
back down (so it is essentially short the stock). For a straddle at-the-money it does not matter so much whether
the stock goes up or down, the only question is how far. However, when the put of the straddle is deep out-the-
money and the call of the straddle is deep in-the-money (or vice versa), both sides (long and short the
straddle) have a marked direction preference. Therefore, delta-hedging can be used.

Nick Leeson and the Barings Bank collapse
Nick Leeson took short straddle positions when chasing losses he had run up for his employer, Barings Bank.
He had initially dealt in futures on the Nikkei 225 stock index. Following a dramatic fall in the market, largely
due to the Kobe earthquake, Leeson lost millions. He tried to re-coup these losses by dealing in the higher risk,
but potentially more rewarding, straddles. He bet that the Nikkei would stabilise and stay in a range around
19,000. His bet failed and losses escalated to $1.4bn, causing the bankruptcy of Barings.[2]
ADDITIONAL INFO:
                                          Option Straddles
If an investor want to trade calls and puts together, for the purpose of taking advantage of a stock's volatility -
they could engage in a straddle strategy.

Long

A long straddle is when a trader buys a call and a put on the same stock hoping the market moves enough in
either direction to cover the premiums spent for the strategy. A long straddle will lose money if the market fails
to move enough where at least one of the option contracts is profitable.



Example:

Buy 1 LPO Jun 80 Call for $300
Buy 1 LPO Jun 80 Put for $200

The strategy here is that the options investor expects movement on LPO stock up or down enough to cover the
total premiums spent, which is $500. The person is neither bullish nor bearish. If the market price on LPO drops
15 points, the investor will be as happy as if the stock rose 15 points. Long Straddles are all about movement
and volatility.

The maximum loss for the trader is $500. That will occur if both contracts expire worthless. The gain can be
made in both directions. If the stock rises, the gain could be unlimited. The investor would just let the put expire
if that happened. Once the marekt rises above 85 (strike price plus combined premiums spent), the gain has no
limit.

The gain potential for the put on this long straddle is $7500. That is based on the stock dropping to zero (not
likely), and the put allowing the options trader to sell the stock at the strike price of 80, minus the $500
premiums spent.

Long straddles are attractive to investors who anticipate fluctuation in the market or on their stock. During times
of uncertainty and unexpected earnings news, can be good times to engage in a long straddle strategy.

Short Strategy

A short straddle is just the opposite in what the investor is thinking. A short strategy is when someone sells a
call and a put on the same stock. They are basically shorting 2 options and hoping the market has little or no
movement. If the market on the stock stays stable or at least within the break-even points of the straddle, then
the options will expire and the trader would be profitable.

The short side of this carries more risk, as the person had two obligations on both sides of the market. The only
way this makes money is if both options last to expieration and expire or if he can close them both out by
trading for them lower than where he sold them short.

Trading Example

Short 1 DFG Oct 40 Call at $200
Short 1 DFG Oct 40 Put at $400
This strategy gives the trader a $600 premium gain. If the options expire, the investor will keep this premium
gain. The risk lies with either of these options getting exercised above or below the break even points. The
break even for the short call is 46 (40 plus the combined 6 points) and 34 for the Put (40 minus the combined 6
points). These stock price levels act as the cushion for the investor. As long as the stock stays within these
points, both contracts should expire worthless and the straddle will be protifable to this investor.

Long positions with options carry less risk than short trading and investing. This is true with straddles - if not
more so.


Next ADDITIONAL ARTICLE:

Who Should Consider Buying Index Straddles?

       An investor who is convinced a particular index will make a major directional move, but not sure
        whether up or down.

       An investor who anticipates increased volatility in an index, up and/or down around its current level, and
        a concurrent increase in overlying options’ implied volatility.

       An investor who would like to take advantage of the leverage that options can provide, and with a
        limited dollar risk.

Buying an index straddle combines the benefits of both an index call and an index put purchase. Leveraged
potential profits can be substantial with a large move in the underlying index either up or down from a certain
level. On the other hand, straddle buyers might instead be focused on short-term increases in call and put
implied volatility levels without a significant move in the underlying index, and taking smaller profits when this
might occur. With either motivation, the amount of capital at risk can be predetermined, and is entirely limited.

Definition

Buying an index straddle involves the purchase of both an index call and an index put on the same underlying
index, with both options having the same strike price and expiration month. A long straddle position is
commonly purchased and sold as a package, i.e., both options bought at the same time to establish the position
as well as sold at the same time to either realize a profit or cut a loss. In a sense, as long as both call and put are
held an investor is hedged, with the bullish call potentially increasing in value with a rise in the underlying
index, and the bearish put increasing with a decrease in the index level.

But as with any long index call or put, the holder of these options can always exercise them before the contracts
expire. American-style index options may be exercised at any time before expiration, while European-style
index options may be exercised only within a specific period of time, generally on the last business day before
expiration. However, any long index option may be sold in the marketplace on or before its last trading day if it
has market value. All index options are cash-settled. For contract specifications for various index option classes,
please visit the Index Options Product Specification area here.

This is neither a bullish nor a bearish strategy, but instead a combination of the two. On the upside, the profit
potential of the long call at expiration is theoretically unlimited as the level of the underlying index increases
above the position’s upside break-even point. On the downside, the profit potential of the long put at expiration
is substantial, limited only by the underlying index decreasing to no less than zero. Again, profit potential for
the long straddle depends on the magnitude of change in the index, not the direction in which it might move.

The maximum loss for the long straddle is limited to the total call and put premium paid. This will occur at
expiration if the index closes exactly at the strike price, and both the call and the put expire exactly at-the-
money and with no value.

There are two break-even points at expiration for this strategy. The upside break-even is an underlying index
level equal to the contracts’ strike price plus the total premium paid for both the call and the put. The downside
break-even is an index level equal to the strike price less the call and put premium paid.

An increase in volatility has a positive financial effect on the long straddle strategy while decreasing volatility
has a negative effect - more so than with either a simple long call or put because two long options are owned.
Time decay has a negative effect on both long options as well.




Example

Say the Federal Reserve has indicated that it is strongly considering raising the Fed Funds rate to control
inflation. Its decision, due in three weeks, will be influenced mainly by the consumer and producer price data
due out in the interim. A jump in interest rates may send stocks sharply lower, while an announcement of steady
inflation and interest rates may boost XYZ to an all-time high. An investor expects that either of these outcomes
could move the market up or down by 5% or more over a timeframe of approximately one month.

Index XYZ is currently at 100. The investor purchases a one-month XYZ 100 call for $1.70, and a one-month
XYZ 100 put for $1.50. The cost for the straddle is: $1.70 (call) + $1.50 (put) = $3.20. The total premium paid
is therefore: $3.20 x 100 multiplier = $320.

By purchasing the straddle the investor is saying that by expiration he anticipates index XYZ to have either
risen above the upside break-even point or below the downside break-even point:

Upside Break-Even Point: 100 strike price + $3.20 straddle cost = 103.20
Downside Break-Even Point: 100 strike price - $3.20 straddle cost = 96.80

The investor’s profit potential is unlimited as XYZ’s level continues to rise above 103.20, or substantial as XYZ
declines below 96.80 by expiration one month away. The risk for the straddle purchase is limited entirely to the
total $320 premium paid for the position, and would be seen if XYZ closes unchanged at expiration at a level of
100.

Before expiration, however, if the straddle purchase becomes profitable because of either a move in index XYZ,
and/or an increase in option implied volatility, the investor is free to sell the position (the call and the put) in the
marketplace to realize this gain. On the other hand, if the investor’s outlook proves incorrect and the level of
index XYZ either does not change much over the next month, and/or the implied volatility does not increase,
the straddle might be sold to realize a loss (due to time decay) less than the maximum.

Consider three possible scenarios at expiration:

       XYZ closes above or below either break-even point at expiration
       XYZ closes between the break-even points at expiration
       Implied volatility changes and straddle sold prior to expiration



Index XYZ is above 103.20 or below 96.80 at expiration


 Buy 1 XYZ 100 Call at $1.70
 Buy 1 XYZ 100 Put at $1.50


If index XYZ closes above the upside break-even point of 103.20 at expiration, at 105 for instance, the put will
expire out-of-the-money and worthless. The call will be in-the-money and worth its intrinsic value, or its cash
settlement amount (difference between the strike price and index level):

  105 XYZ index level
-$100 call strike price
   $5 intrinsic value (cash settlement amount)

On the other hand, if index XYZ closes below the downside break-even point of 96.80 at expiration, at 95 for
instance, the call will expire out-of-the-money and worthless. The put will be in-the-money and worth its
intrinsic value, or its cash settlement amount (difference between the strike price and index level):

 $100 put strike price
  -95 XYZ index level
   $5 intrinsic value (cash settlement amount)

In either instance, if you sell the XYZ 100 call or put for its intrinsic value of $5, or exercise either in-the-
money option and receive its cash settlement amount, then you would see a profit:

 $5.00 intrinsic value or cash settlement amount for call or put
-$3.20 total premium initially paid for straddle
 $1.80 profit

The investor’s prediction of at least a 5% move in XYZ index up or down (from 100 to either 105 or 95) has
proven true. The upside or downside profit of $1.80 ($180 total) represents a return on an initial investment of
$3.20 premium paid for the call ($320 total) of approximately 56.3% over the 1-month life of the straddle.

Index XYZ is between 103.20 or below 96.80 at expiration
 Buy 1 XYZ 100 Call at $1.70
 Buy 1 XYZ 100 Put at $1.50


With index XYZ exactly at the strike price of 100 at expiration, both the 100 call and the 100 put would expire
exactly at-the-money and with no value. The maximum, predetermined loss of $3.20 (or $320 total) would be
realized.

At expiration, with XYZ at either the upside break-even point of 103.20, or the downside break-even point of
96.80, the call or puts intrinsic value would be $3.20, the initial cost of the whole straddle.

With XYZ closing at expiration between 103.20 and 96.80, but not at the 100 strike price, one of the options
would expire in-the-money and have intrinsic value, with the other expiring worthless. In this case the in-the-
money option could be either sold or exercised to recoup some of the original straddle purchase price resulting
in a partial loss for the position.

For example, index XYZ closes at 102 at expiration. The put would expire out-of-the-money and with no value,
and the call would have an intrinsic value (or cash settlement amount) of:

  102 XYZ index level
-$100 call strike price
   $2 intrinsic value (cash settlement amount)

The level of index XYZ did change over one month, but not as much as anticipated. The straddle that cost $3.20
is now worth only the intrinsic value of its in-the-money call, or $2. The investor could sell the call and recoup
some of the straddle’s initial purchase price. If the XYZ 100 call is sold for its intrinsic value of $2 then the loss
for the position would be:

 $3.20 premium initially paid for straddle
-$2.00 premium received at call’s sale
 $1.20 partial loss

With XYZ at 102 at expiration, the in-the-money XYZ 100 call could also be exercised. The exercise settlement
value would be the closing index level of 102. The cash settlement amount would be: 102 (settlement value) –
$100 (call strike price) = $2. The partial loss would be the same as if the call were sold for intrinsic value at
expiration:

 $3.20 premium initially paid for straddle
-$2.00 premium received at call’s exercise
 $1.20 partial loss

Volatility Change Before Expiration


 Buy 1 XYZ 100 Call at $1.70
 Buy 1 XYZ 100 Put at $1.50


Say index XYZ fluctuated up and down around the level of 100, its level when the straddle was purchased, and
10 days after purchase (20 days before expiration) it was again at the level of 100. Time decay would have its
natural, negative effect on the value of both options. But assume the investor initially bought the straddle
motivated more by a predicted increase in option implied volatility than an expected change in the level of
XYZ, and that this prediction proved true.

The straddle was originally purchased at an implied volatility level of approximately 14%, but say the volatility
level is now approximately 19%. What prices might the investor expect to see in the marketplace for both the
long at-the-money call and put, given no change in interest rates or dividend yield of the underlying index?

  XYZ 100 call = $1.85 expected value
  XYZ 100 put = $1.70 expected value
XYZ 100 straddle = $3.50 expected value

If the investor could sell the straddle at these expected values for both the call and put, the total received would
be $3.50, or $350 total. The investor would make a profit:
 $3.50 straddle sale price
-$3.20 straddle cost
 $0.30 profit

The investor’s $0.30 profit ($30 total) after owning the XYZ 100 straddle for 10 days, with the underlying index
level unchanged, would come from the expected increase in option implied volatility. This $30 represents a
return on the initial $320 investment of 9.4% over 10 days. If during this 10-day period the option implied
volatility actually decreased, which was not expected by the investor, the straddle would most likely show a loss
due to time decay with XYZ unchanged at a level of 100.

While holding the straddle in anticipation of an implied volatility increase, the investor was in a sense protected
from a significant move in XYZ, up or down, which was not part of his prediction. In fact, if the level of index
XYZ had increased (or decreased) dramatically while owning the straddle, a profit might have been made from
a concurrent increase in value of the call (or the put) instead, without an implied volatility increase.

 For those who expect a move up or down in an underlying index over a given timeframe, buying an index
straddle might be an appropriate strategy to consider. If expectations of an index move come true, an investor is
positioned to profit on either the upside by owning a call or the downside by owning a put at the same time.

At expiration, the profit potential on the upside from the long call is theoretically unlimited. On the downside
the profit potential from the long put is substantial, limited only by the underlying index declining to no less
than zero. The maximum loss for the long straddle is limited to the total premium paid for the call and put, and
will generally occur at expiration with the underlying index closing at the straddle’s strike price and both at-the-
money options expiring with no value.

Time decay has an especially negative effect on a long straddle because this decay is simultaneously working
against the straddle owner on two long options, a call and a put. The straddle owner is also especially vulnerable
to changing volatility while holding the straddle. A decrease in volatility has a simultaneous negative effect on
both the long call and long put. On the other hand, an increase in volatility will have a positive effect on the
market prices of both the call and the put, which can possibly overcome the natural time decay in their values
and result in a profit without a move in the underlying index. This might be another motivation for purchasing
the straddle in the first place.

End of current Article.   ///
STRADDLES VS STRANGLES - SHORT TUTORIAL:

  Strangle: A trading position involving puts and calls on a one-to-one basis in which the puts and
 calls have the same expiration and underlying stock but different strike prices. We buy Out-Of-
 The-Money strike puts and OTM strike calls.

 Straddles and strangles are both options strategies that allow the investor to gain on significant moves either up
or down in a stock’s price. Both strategies consist of buying an equal number of call and put options with the
same expiration date; the only difference is that the strangle has two different strike prices, while the straddle
has one common strike price.

For example, let’s say you believe your favorite diamond mining company is going to release its latest results in
three weeks time, but you have no idea whether the news will be good or bad. This would be a good time to
enter into a straddle, because when the results are released the stock is likely to be more sharply higher or lower.

Let’s assume the price is currently at $15 and we are currently in April 05. Suppose the price of the $15 call
option for June 05 has a price of $2. The price of the $15 put option for June 05 has a price of $1. A straddle is
achieved by buying both the call and the put for a total of $300: ($2 + $1) x 100 = 300. The investor in this
situation will gain if the stock moves higher (because of the long call option) or if the stock goes lower (because
of the long put option). Profits will be realized as long as the price of the stock moves by more than $3 per share
in either direction. A strangle is used when the investor believes the stock has a better chance
of moving in a certain direction, but would still like to be protected in the case of a
negative move.
For example, let's say you believe the mining results will be positive, meaning you require less downside
protection. Instead of buying the put option with the strike price of $15, maybe you should look at buying the
$12.50 strike that has a price of $0.25. In this case, buying this put option will lower the cost of the strategy and
will also require less of an upward move for you to break even. Using the put option in this strangle will still
protect the extreme downside, while putting you, the investor, in a better position to gain from a positive
announcement.

End this article.

				
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