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Buy Straddle - An Option Trading Strategy

Today's article will show the Buy straddle or long straddle options strategy. This strategy includes buying and selling the call option contract and put the option contract together having the same strike price and same expiry date. As a long straddle strategy includes buying two option contracts, it can be placed under the category of a multi-legged strategy. It is a good choice for beginners to learn trading with multi-legged contracts.


Market outlook:

This strategy is perfect to implement when the market is highly volatile. When you expect big moves in the underlying asset's price but are unsure about the direction of movement, the buy straddle option strategy must be implemented in such scenarios.


The high volatility can be seen for many reasons, such as any major announcements, budget declarations, the AGM of a company, any War-like situation between two countries, elections, policy change, etc. The market is highly volatile during all such times, and you cannot predict whether it will rise or fall.


Benefits of implementing the buy straddle option strategy:

In this strategy, the profit potential is unlimited, and the risk is limited only to the premium paid to buy two contracts. You can earn profit from both directions. Regardless of the underlying asset's price movement, you can make money in this situation. The higher volatility will result in a higher yield. Thus, we can say volatility is a friend of the buy-straddle option strategy.


How to enter the buy straddle option strategy:

To enter the strategy, traders must buy two option contracts, one call and another put option contract. Both of them must have the same strike price and the same expiry date.


There are two methods to exit from the strategy. They are as below:

  • Buy Call option contract.

  • But Put option contract.

Break-even point of this strategy:

As this strategy has two contracts involved, it will have two break-even points as follow:

  • Lower breakdown point = strike price - the premium paid

  • Upper breakdown point = strike price + the net premium paid

Illustration

Eg. Nifty is currently trading @ 5500. Long Straddle can be created by Buying Call and Put Option for Strike 5500 having premium of 65 and 35 respectively. Net outflow of premium is 100.

Payoff Shedule

NIFTY @Expiry

Net Payoff (Rs.)

4900

20000

5000

15000

5100

10000

5200

5000

5300

0

5400

-5000

5500

0

5600

5000

5700

10000

5800

15000

5900

20000


Buy Straddle - An Option Trading Strategy

In the above chart, the breakeven happens the moment Nifty crosses 5300 or 5500 and risk is limited to a maximum of 5000 (calculated as Lot size * Premium Paid). Here it is important to note that the premium is calculated as the sum of premium paid for the Call and Put option.


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