Many times the traders will have to face the situation when they can either choose the Long Straddle or Short Straddle after thinking so much about it. Only after choosing the right strategy, you can proceed with planning and put in the right efforts.
A Long Straddle is a strategy in options that helps the traders to buy a long “call option” and also a long “put option”. These options include the same asset (underlying) and have the same strike and expiry date.
Most professional traders prefer the best strategy that is not commonly selected by the other traders in the market and try to overcome the volatility in the market.
Long Straddle may be the easiest market-neutral strategy that the traders implement to earn profits against the unfavorable market direction. It is impossible for even experienced traders to predict the movements of the market and to predict the direction in which it will go. Therefore they have to rely on historical data, market trends, sentiments, and strategies.
There are two ways you can use the Long Straddle; buying a call option and buying a put option.
Let us understand Long Straddle with a simple example,
Let us say the market is trading at the price of 7579. This makes the ATM (At the Money) strike price at 7600. Now with the Long Straddle, you have to buy the ATM Call Option and then ATM Put Option.
Let’s say that the 7600 CE is traded at Rs.77 and the 7600 PE is traded at Rs.88. So, here the purchase of both the options is around Rs.165 by adding 77 and 88. Remember both of these options are purchased simultaneously. So here with Long Straddle, the trader is not at all worried about market volatility as he is long on both the call option and put option.
If the market goes upwards, then the traders will benefit from the higher profit or gain in Call Options than the loss of put option premium paid. And if the market goes downwards, then the traders can expect to gain from the Put option.
This gain would surpass the loss of the call option. So, here regardless of the direction, the gain with one option will be enough to easily offset the loss occurring in the other option. There will be a positive yield in profit and loss.
So, regardless of market direction, you can make a profit easily in one option by offsetting another. Let us consider this with different situations.
Situation 1 –
Market expiration at 7200 where you earn money with a put option
In this situation, the put options gain will give you profit and also offset the loss of the call option. When the market expiry is at 7200, you can expect below,
The loss of Rs.77 premium once the 7600 CE expires.
7600 PE will get Rs.400 as an intrinsic value. You will get 312 after adjusting it for the premium Rs.88. Here is how you can calculate 400-88=312.
The total payoff would be around "+325" which you get by calculating by subtracting 312 to 77.
So here, you can understand that the put option gains after you adjust it for the put option premium that you paid. Once you adjust the option call premium that you pay and it would still give you a profit.
Situation 2 –
Market expiration at 7435 where there is a lower breakdown
Here there is no loss incurred and no gain. You do not make any money but also do not lose it.
The premium that you paid would be written off and 7600 CE would worthlessly expire.
7600 PE will not have Rs.165 which then would be adjusted with the put options gain.
Rs.165 is the net premium that you pay for the call option and put option. This is later adjusted for put options gain.
The market would expire at a lower value if you think in terms of ATM Strike. This is the reason the put option makes the money. But here, the put options gain is adjusted to the premium paid by you for the options both call and put. Ultimately it would leave no money with you.
Situation 3 –
Market Expiration at 7600 (here at the ATM Strike)
In this situation, at 7600, you will see that the call and put both the options would worthlessly expire and because of this the premium you have paid would be no more. So, your loss is equivalent to the Rs.165 net premium that you paid.
Situation 4 –
Market Expiration at 7765 (this is the upper breakeven point)
Here in this situation, the breakeven point of this strategy would be above the ATM Strike.
It would gain an option when the 7600 CE will have Rs.165 as an intrinsic value.
Here, the 7600 PE would worthlessly expire and therefore you will lose the premium that you paid for the option
At 7600 CE, the gain you make would easily offset the combined paid premium.
So you will find the strategy’s breakeven point.
Situation 5 –
Market Expiration at 8000 (here the call option would earn money)
In this situation, the market would already be higher than the 7600 ATM. Here the premium would be larger, the call options gain would become more and this would offset the paid premium.
● The Rs.88 premium you will need to be written off, therefore the 7600 CE would be worthless.
● The 7600 CE at 8000 would possess Rs.400 as an intrinsic value.
● So, here the “+235” would become the net payoff (400-88).
So, as you can observe above, the call options gain is quite significant that helps you offset the combination of the premium you paid. The loss may occur with you at 7600. This is the ATM strike point. Here you will find that in any direction, the profit is limited.
This is a very simple strategy to understand and implement. So traders choose this strategy to buy calls and puts that have very limited downsides. Because of this, you can earn unlimited profits.
What is the importance of Volatility while implementing Straddle?
Volatility is very important when it comes to implementing straddles. Volatility can either make it straddle or break it. So, before taking any step with the strategy, you have to do a proper assessment of the Volatility because it will serve you as a backbone for the success of your straddle. With the proper assessment of Volatility, you can even double your current profit using straddle.
At the beginning of the month, it is easier for you to start with the long straddle strategy. When you are setting up the straddle, the Volatility is low. After successfully setting up the straddle, your Volatility will also double.
Delta Neutral about strategy
When we talk about the strategy, we have to talk about the delta as well. Because the trader is long on the ATM Strike, The delta will most likely be 0.5 for both options.
The call option delta is going to offset the put option delta and therefore the value would be 0 to the overall delta. The recall delta indicates the position's direction bias. The positive delta shows that there is a bullish bias. The negative delta shows that there is a bearish bias.
So considering this situation, the delta showing zero shows the investors that there is zero bias in the market direction. So every strategy that has zero delta value is known as Delta Neutral. The strategies which are Delta Neutral are going to be protected against the direction of the market.
So, in a nutshell, the Delta Neutral is a strategy that balances the positive deltas and negative deltas of multiple positions. And by using this portfolio strategy, the traders get an idea about the movements in the market considering a particular range. This brings the net change in the position to zero.