A straddle is the simultaneous purchase or sale of both a call and a put at the same strike and expiration for a particular underlying security.
A long straddle is the purchase of both a call and a put at the same strike price and expiration on the same stock or index. This is a capital-intensive trade as it involves paying two premiums. The trader is purchasing time value on both the call and put sides, and typically needs a fast, large move either up or down in order to produce a profit.
A large move would cause the call or put to go deep ITM, and a move with great velocity would inflate the volatility component of price as well. Because only one of the options (either the call or the put) can expire ITM, a straddle buyer needs one option to gain more value than the other side loses in order to turn a profit as price moves away from the strike.
A short straddle is the sale of both a call and a put at the same strike price and expiration on the same stock or index. This is a play where the underlying stock is not expected to move much in the near future and the premium collected on both sides is expected to erode as time passes.
Straddles are generally done at the money, so the nearest strike to the current price is the go-to strike for most straddles.
It’s common for straddles to be done around scheduled events (such as earnings announcements) when a big move is expected but direction is unknown. In such cases, implied volatility is often already priced higher and is therefore poised for a contraction. This causes rich premiums, making it even more imperative that a significant move occurs for straddle buyers.
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