What is a long straddle?
A long straddle is a strategy that involves buying a call and a put option with the same expiration date and the same strike price, at the same time. Long straddles are usually initiated when the stock price trades at the same level as the strike price of the options. But you can also set them up to be bullish or bearish, depending on where you want the stock price to go.
This a a strategy suited for risk-averse traders because the maximum loss you can incur from a long straddle is set by the combined cost of the long call and long put. If the underlying stock makes a big move in either direction, or if implied volatility increases, you can profit from this strategy.
When to use a long straddle strategy
A long straddle is a market-neutral strategy that doesn't have a bias in any particular direction. However, it profits only if there is a large enough move in the underlying asset price, or if volatility increases significantly before expiration.
This means it’s best to use a long straddle strategy when you anticipate the price of the underlying stock to move a lot. This environment benefits a long straddle position because the strategy makes money when implied volatility increases.
How to manage a long straddle position
If you have initiated a long straddle position, time decay is working against you in full force. It will cause the value of both options to decrease. What you really want is implied volatility to increase.
This will make the value of both your options increase, and it also suggests that there is a greater chance of a favorable price swing.
Of course if implied volatility decreases, it will reduce the value of both of the options you hold. This would result in a compounding of losses.
Long straddle maximum profit potential
If the stock price rises, the potential profit for a long straddle position is in theory unlimited. However, if the stock falls, the potential profit is limited to how much lower the stock price falls than the strike price minus how much debit you paid to enter the position.
Long straddle maximum loss potential
The most a person can lose from a long straddle is the net debit they paid when they initiated the trade.