Explanation

Long straddle is one of the most commonly used option strategies in the volatile market. This option strategy is used when the trader is sure about the level of volatility but is indifferent in term of direction. Execution of this strategy involves buyingcall and put options. Call and Put optionshould be of same strike price, same expiry date and of the same underlying asset. The option buyer will only make money if the price of the underlying rise or fall significantly. If the underlying fall the long put will earn profit and call will expire worthless and vice a versa.

Risk

Risk in long straddle is limited to premium paid.

Reward

Reward can be limitless if the market scenario plays as per trader expectation

Construction

Buy 1 Call Option

Buy 1 Put Option

PayoffChart

Option Trading Example

Suppose the Nifty index is trading at 17779.4 and the trader is very bullish on the volatility of the underlying asset but don’t know in which direction will be underlying go. He thinks of implementing long straddle option strategy. He bought 17800 call at premium of 50 and 17800 put at a premium of 57. His net investments will be Rs. 5350. [(50 + 57)*50]

Scenario 1:

At expiry if NIFTY fell drastically and closed at 17400 level, then the call will expire worthless and the trader will profit from the Put option. The profit will be equal to Rs. 14600 ((17800 – 17400 - 57) – 51) *50).

Scenario 2:

If at supply, the underlying expires in range of 17800, both the call and put option will expire worthless and the trader will lose the premium paid i.e. 5350.

Scenario 3: At expiry if NIFTY rose significantly and closed at 18100 level, then the put will expire worthless and the trader will profit from the call option. The profit will be equal to Rs. 9600 ((18100 – 17800 - 51) – 57) *50).