When you are trading stock options, it is important to understand the different strategies available to you. One of those strategies is called a long straddle. A long straddle is a strategy where you buy both a call option and a put option at the same time with the same strike price and the exact same expiration date. In this article, we will discuss what a long straddle is and tips for trading them successfully!
Long Straddle Options Strategy
Options are a risky strategy when day trading and may be difficult if you do not know what you are doing. Many traders struggle with purchasing long call and put options. These both require that you pick the correct trade direction. Pick the wrong trade, then you will lose. But what if we told you about an options trading strategy that will allow you to make money if the market goes in either direction?
A long straddle is an excellent strategy for traders who expect a big move in the market but are unsure which direction it will go. Think of a straddle like a trader ‘straddling the fence’. You do not need to have a bullish or bearish bias. The beauty of this strategy is that you can make money if the market goes up, down, or sideways! Long straddles can be traded on all trading platforms that support options trading. However, since this is a multiple-leg strategy, it requires additional approval from your options broker.
Once you have the correct level of options approval, creating a long straddle requires you to buy a call and a put option simultaneously. Both of these options have the same strike price and expiration date. The strategy is optimal when the market moves significantly in one direction, allowing one option’s price to increase and cover the loss from the other option. Therefore, you do not have to know which direction the market will move, only that you expect it to move sharply in one direction over the other.
See this example below of the steps to purchase a long straddle on thinkorswim.
1. Open up the platform. Navigate to the ‘Trade’ tab.
2. Type in the underlying stock to be traded.
3. Open the Option Chain. Change ‘Single’ to ‘Straddle’
4. Select the Expiration Date and the Strike Price. Double-click the ‘Ask’ price to create an order.
5. Ensure the order indicates to buy both the Call and the Put.
6. Select the Order Type (Market, Limit Price, etc.), Quantity. Select Confirm.
7. Select Confirm and Send.
8. Once confirmed, select Send.
Long Straddle Notes
You must be aware of the following before trading long straddles.
#1 – First, you must make sure you pick a suitable expiration date. If the market doesn’t move enough by the expiration date, your options will expire worthless, and you will lose money. Most experts recommend choosing the same expiration date very far in the future to give the trade enough time to move significantly in either direction.
#2 – Second, you need to be aware of the Greeks. The option Greeks are measures of risk that all options traders need to understand. Options traders need to be mindful of these Greeks because they can significantly impact their trades’ profitability. These include calculations like delta, gamma, vega, and theta. Here are descriptions of each:
- Delta provides a measure of how much the option price is expected to change in comparison to the underlying asset price. A trader who is long a call option with a delta of 0.50 and the underlying asset increases in price by $0.50 will see their options increase in value by $0.25 (delta x $0.50). If the underlying asset increases in price by $0.40 and the option’s delta is 0.60, then the option will increase in value by $0.24 (delta x $0.40).
- Gamma measures the change in delta for the underlying asset price. A trader who is long a call option with a gamma of 0.20 and the underlying asset increases in price by $0.50 will see their option’s delta increase by 0.01 (gamma x $0.50). If the underlying asset decreases in price by $0.40 and the option’s gamma is -0.30, then the option’s delta will decrease by 0.012 (-gamma x $0.40).
- Vega measures how much implied volatility is embedded in the option price. A trader who is long a call option with a vega of 0.20 and the underlying asset’s volatility increases by one percent will see their options increase in value by $0.04 (vega x 0.01). If the underlying asset’s volatility decreases by one percent and the option’s vega is -0.30, then the option will decrease in value by $0.09 (-vega x 0.01).
- Theta is a measure of the time decay of the option. A trader who is long a call option with a theta of -0.25 will see their option decrease in value by $0.25 (-theta x 0.25) for one single day.
By understanding the option Greeks, options traders can better manage the risk of their trades and potentially increase their profits.
#3 – Lastly, you need to ensure that you have the right risk management. This means having a stop loss in place to limit your losses if the market moves against you. This ensures you have set up your maximum loss parameters. Also, review what your breakeven points will be to ensure that you can remain profitable with the strategy.
Long Straddle Strategy Tips
If you are thinking of trading long straddles, we have a few tips for you!
#1 – Make sure that you understand the risks involved. Holding positions too long could cause losses on your call and put options. So, it is always good to paper trade straddle first to ensure you have a strategy for trading them, know where to stop losses, and set your take profit levels.
#2 – Don’t be afraid to take profits early if the market moves in your favor! If you have net profit on your call and put position, then there is nothing wrong with taking profits early or creating a scaling plan to lock in some profits.
#3 – Look for upcoming news to trade straddles. To successfully trade straddles requires volatility and strong moves in the market for your gains to offset losses. To anticipate strong moves in the market, look for news events related to whatever underlying that you are interested in trading.
- Company News: Company Reports, Earnings announcements, FDA trial results, Legal announcements
- Market news: Economic news, market reports, unemployment numbers, interest rates, inflation rates
#4 – Top Tip – Many traders who choose to trade straddles look for strike prices around the current price. So, the price is set up to go either direction.
Summary: Long Straddle Strategy
A long straddle is one of the many options trading strategies available today. It is used because it allows the average trader to make money if the market goes in either direction. This can be an excellent strategy for traders unsure which direction the market will move.
Our strategy teaches you how to read market direction more easily to know which side of the market you should be on. Would you like to be able to read market direction better and join our community of traders who are making money as day traders?
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