Learn With ETMarkets: Options Demystified 503 – Straddles

In their ongoing discussion about options trading and after explaining to Tara about directional spreads, Maya decided to introduce Tara to non-directional strategies.

These strategies, also known as Delta neutral strategies, can be profitable in various market conditions, including periods of high or low volatility.

Straddles: Profiting from Uncertainty

Maya explained, "Let's start with Straddles. This options trading strategy involves buying both a call option and a put option on the same underlying asset, with the same expiration date and strike price."

"To illustrate, consider the Nifty index, currently at 19,659," Maya continued. "You believe that Nifty is about to make a significant move, but you're uncertain about the direction. In such a scenario, you can implement a straddle by buying a 19,650 call option (for Rs 170) and a 19650 put option (for Rs 72). By doing this, you're paying a premium of 242 (170 + 72), and you'll profit from a substantial move beyond 242 points in either direction (below 19408 or above 19892). In such a big move, one option will expire worthless, but the other will yield profits above the premium of 242 you paid."


Tara inquired, "But if the prices don't move much and expire at the strike price of 19650, both options will expire worthless, right?"

Maya confirmed, "Yes, that's the maximum risk in a straddle—limited to the premium you pay for both options. The reward is virtually unlimited if the asset moves significantly in either direction. Here's the risk-reward profile for a straddle."


Tara then wondered, "So, we should consider a straddle when we expect a big move due to some macro event that impacts prices, right?"

Maya replied, "Exactly! Straddles work best when you anticipate a significant price movement but are unsure about the direction. Consider implied volatility, as high volatility can increase the straddle's cost. Ensure the straddle's cost doesn't exceed your potential profits, as you need a considerable price swing to be profitable. Time until expiration also plays a role—the longer the time frame, the higher the potential for price movement, increasing the straddle's chances of success."

Tara further asked, "If premiums are high due to implied volatility, what can we do?"

To be continued…

(The author is CEO Yubha.com, TradingHeads.com)

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)