Straddle

If you can’t decide whether to be a bullish or bearish, here’s a strategy for you. You do have to decide one thing and that is whether the stock is going to make a big move or stay in a small range of prices. The straddle is neutral regarding the direction of the move.

The long straddle is buying a call option and a put option in the same stock at the same strike price with the same expiration date. If this sounds like a neutral sort of thing to do, then you simply have to remember that a losing option does not lose you any more money than the premium you have already paid – it simply expires worthless. If you think the price is going to move a long way from its current levels, you buy the call option and the put option, a long straddle, and your total downside risk is the premium paid for these. One of them expires worthless, and the other makes you a profit any time the stock moves up or down by more than the premium cost. If you were to graph this, the price zone where you would lose money is a small region either side of the strike price. If the price goes outside this zone, then one or other of the options will continue to increase in value.

The alternative is a short straddle, which you would take out if you thought the stock was not moving much. This is the opposite position, where you sell both the call and the put. In other words, you are taking out a writing position for the long straddle. As with all writing positions, your profit comes up front when you are paid for the options. Your profit is limited to this premium, and your downside can be unlimited if the stock price changes. You will have to pay out on either the put or the call however much the price moves.

Strangle

There is another way to play the straddle, and that is called the strangle. This is very similar to the straddle, but it has different strike prices for the call and the put. This makes it cheaper to trade, but your maximum loss, the premium paid, will happen for the range of prices from one strike price to the other. Once again, it is a strategy that you use when you think that the stock price is going to vary a lot from its current position. Because you have taken out a strangle and not a straddle, the price must move further away from the middle position in order to go into profit, in other words the price range where there is no profit is wider.

As with the straddle, you can also take the short position called the short strangle, writing the call and the put, and receive premiums. The premiums you get will be less, but you will get the full amount over the range of prices from call to put. Because of the wide range you are less likely to lose money writing these options, but once again your theoretical liability is infinite. However, if the price settles between the two different strike prices, you have no commitment to fulfil and you achieve the maximum profit of the premiums received.

Options traders have many other strategies, which represent various ways of looking at the market. Another one of the better-known strategies is the Butterfly with its variations. This uses three different strike prices, and can be configured to profit from very little underlying price movement, or from substantial price movement. It is truly possible to profit from a market that is going nowhere, but you will always need to have an opinion that is substantially correct so that you take the right position.

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