Straddle: Difference between revisions
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{{Short description|Options combination in finance}} |
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{{about|the financial investment strategy}} |
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{{about|the combination of financial derivatives}} |
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{{more footnotes|date=March 2016}} |
{{more footnotes|date=March 2016}} |
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In [[finance]], a '''straddle''' |
In [[finance]], a '''straddle''' strategy involves two transactions in [[option (finance)|options]] on the same [[underlying]], with opposite positions. One holds [[Long (finance)|long]] risk, the other [[Short (finance)|short]]. As a result, it involves the purchase or sale of particular [[option (finance)|option]] [[derivative (finance)|derivatives]] that allow the holder to profit based on how much the price of the [[underlying]] security moves, regardless of the ''direction'' of price movement. |
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A straddle involves buying a call and put with same strike price and expiration date. If the stock price is close to the strike price at expiration of the options, the straddle leads to a loss. However, if there is a sufficiently large move in either direction, a significant profit will result. A straddle is appropriate when an investor is expecting a large move in a stock price but does not know in which direction the move will be.<ref>{{Cite journal|last=S|first=Suresh A.|date=2015-12-28|title=ANALYSIS OF OPTION COMBINATION STRATEGIES|url=http://inflibnet.ac.in/ojs/index.php/MI/article/view/3554|journal=Management Insight|language=en|volume=11|issue=1|issn=0973-936X}}</ref> |
A straddle involves buying a [[call option|call]] and [[put option|put]] with same [[strike price]] and expiration date. If the stock price is close to the strike price at expiration of the options, the straddle leads to a loss. However, if there is a sufficiently large move in either direction, a significant profit will result. A straddle is appropriate when an investor is expecting a large move in a stock price but does not know in which direction the move will be.<ref>{{Cite journal|last=S|first=Suresh A.|date=2015-12-28|title=ANALYSIS OF OPTION COMBINATION STRATEGIES|url=http://inflibnet.ac.in/ojs/index.php/MI/article/view/3554|journal=Management Insight|language=en|volume=11|issue=1|issn=0973-936X}}</ref> |
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A straddle made from the ''purchase'' of options is known as a '''long straddle''', '''bottom straddle''', or '''straddle purchase''', while the reverse position, made from the ''sale'' of the options, is known as a '''short straddle''', '''top straddle''', or '''straddle write'''.<ref name="Hull 2006 options 234-236">{{cite book |last1=Hull |first1=John C. |authorlink=John C. Hull (economist) |title=Options, futures, and other derivatives |date=2006 |publisher=Pearson/Prentice Hall |location=Upper Saddle River, N.J. |isbn=0131499084 |pages=234–236 |edition=6th}}</ref><ref>{{cite book |last1=Natenberg |first1=Sheldon |title=Option volatility and pricing: advanced trading strategies and techniques |date=2015 |location=New York |isbn=9780071818780 |edition=Second |chapter=Chapter 11}}</ref> |
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The ''purchase'' of particular option derivatives is known as a '''long straddle''', while the ''sale'' of the option derivatives is known as a '''short straddle'''. |
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==Long straddle== |
==Long straddle== |
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[[Image:Longstraddle.png|thumb|An option payoff diagram for a long straddle position]] |
[[Image:Longstraddle.png|thumb|An option payoff diagram for a long straddle position]] |
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A '''long straddle''' involves "going long |
A '''long straddle''' involves "going long volatility", in other words purchasing both a [[call option]] and a [[put option]] on some [[stock]], [[interest rate]], [[index (economics)|index]] or other [[underlying]]. The two options are bought at the same [[strike price]] and expire at the same time. The owner of a long straddle makes a profit if the underlying price moves a long way from the strike price, either above or below. Thus, an investor may take a long straddle position if he thinks the market is more [[Volatility (finance)|volatile]] than option prices suggest, but does not know in which direction it is going to move. This position is a limited risk, since the most a purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential.<ref>{{cite book |title=The Complete Idiot's Guide to Options and Futures |last=Barrie |first=Scott |year=2001 |publisher=Alpha Books |isbn=0-02-864138-8 |pages=120–121 }}</ref> |
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For example, company XYZ is set to release its quarterly financial results in two weeks. A trader believes that the release of these results will cause a large movement in the price of XYZ's stock, but does not know whether the price will go up or down. He can enter into a long straddle, where he gets a profit no matter which way the price of XYZ stock moves, if the price changes enough either way. If the price goes up enough, he uses the [[call option]] and ignores the [[put option]]. If the price goes down, he uses the [[put option]] and ignores the [[call option]]. If the price does not change enough, he loses money, up to the total amount paid for the two options. The risk is limited by the total premium paid for the options, as opposed to the short straddle where the risk is virtually unlimited. |
For example, company XYZ is set to release its quarterly financial results in two weeks. A trader believes that the release of these results will cause a large movement in the price of XYZ's stock, but does not know whether the price will go up or down. He can enter into a long straddle, where he gets a profit no matter which way the price of XYZ stock moves, if the price changes enough either way. If the price goes up enough, he uses the [[call option]] and ignores the [[put option]]. If the price goes down, he uses the [[put option]] and ignores the [[call option]]. If the price does not change enough, he loses money, up to the total amount paid for the two options. The risk is limited by the total premium paid for the options, as opposed to the short straddle where the risk is virtually unlimited. |
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If the stock is sufficiently volatile and option duration is long, the trader could profit from both options. This would require the stock to move both below the put option's strike price and above the call option's strike price at different times before the option expiration date. |
If the options are [[American option|American]], the stock is sufficiently volatile, and option duration is long, the trader could profit from both options. This would require the stock to move both below the put option's strike price and above the call option's strike price at different times before the option expiration date. |
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===Example: Long straddle P/L graph=== |
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This is an at-the-money (ATM) Straddle with 1 year to expiry: |
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[[File:Long Straddle Option Strategy Example.png|thumb|Example of long straddle option strategy]] |
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After 50 days, the P/L graph of the straddle will look as follows (blue line): |
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[[File:Straddle Option Strategy Profit-Loss Graph.png|thumb|Example straddle option strategy profit-loss graph]] |
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The P/L blue graph is ''negative'' at prices from approximately 84 to 107 dollars (these are the break-even points), which means that in order for the strategy to be profitable after 50 days, the stock price should be either higher than 107 dollars or lower than 84 dollars. |
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As time goes by, due to time decay, the straddle P/L graph goes down (and becomes more and more unprofitable), until it reaches the orange line (which is the P/L of the straddle at expiry). Also, the distance between the break-even points increases. |
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==Short straddle== |
==Short straddle== |
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[[Image:Shortstraddle.png|thumb|]] |
[[Image:Shortstraddle.png|thumb|]] |
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[[Image:Short straddle.JPG|thumb|]] |
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A '''short straddle''' is a non-directional [[options strategy|options trading strategy]] that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date. The profit is limited to the premium received from the sale of put and call. The risk is virtually unlimited as large moves of the underlying security's price either up or down will cause losses proportional to the magnitude of the price move. A maximum profit upon expiration is achieved if the underlying security trades exactly at the strike price of the straddle. In that case both puts and calls comprising the straddle expire worthless allowing straddle owner to keep full credit received as their profit. This strategy is called "nondirectional" because the short straddle profits when the underlying security changes little in price before the expiration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call. |
A '''short straddle''' is a non-directional [[options strategy|options trading strategy]] that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date. The profit is limited to the premium received from the sale of put and call. The risk is virtually unlimited as large moves of the underlying security's price either up or down will cause losses proportional to the magnitude of the price move. A maximum profit upon expiration is achieved if the underlying security trades exactly at the strike price of the straddle. In that case both puts and calls comprising the straddle expire worthless allowing straddle owner to keep full credit received as their profit. This strategy is called "nondirectional" because the short straddle profits when the underlying security changes little in price before the expiration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call. |
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The risk to a holder of a short straddle position is unlimited due to the sale of the call and the put options which expose the investor to unlimited losses (on the call) or losses limited to the strike price (on the put), whereas maximum profit is limited to the premium gained by the initial sale of the options. Losses from a short straddle trade placed by [[Nick Leeson]] were a key part of the collapse of [[Barings Bank]].<ref>{{Cite web|url=https://www.next-finance.net/How-Nick-Leeson-caused-the|title=Stories - How Nick Leeson caused the collapse of Barings Bank|first=Paul|last=Monthe|website=Next Finance}}</ref> |
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== |
==Straps and strips== |
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{{multiple image |
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A '''tax straddle''' is straddling applied specifically to taxes, typically used in [[Futures contract|futures]] and options to create a [[tax shelter]].<ref name="irs">{{cite web |url= http://www.irs.gov/Businesses/Passthrough-Entity-Straddle-Tax-Shelter|title=Passthrough Entity Straddle Tax Shelter|last1= |first1= |last2= |first2= |date= |website= |publisher= IRS.gov|accessdate=Jan 9, 2015}}</ref> |
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| image1 = Optsioonid Strap.png |
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| alt1 = |
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| image2 = OptsioonidStripPO.png |
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| alt2 = |
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| footer = Rough example payoff diagrams of a strap (left) and a strip (right) |
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}} |
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'''Straps''' and '''strips''' are modified versions of a straddle.<ref>{{cite web |title=Strap Explained |url=https://www.theoptionsguide.com/strap.aspx |website=www.theoptionsguide.com |access-date=5 January 2022}}</ref> Whereas a straddle consists of one put and one call at the same strike price, a strap consists of two calls and one put at the same strike price, while a strip consists of one call and two puts. Like a straddle, a strap or a strip allows the trader to profit from a large move in either direction, but while a straddle is directionally neutral, a strap is more bullish (used by a trader who considers an increase more likely than a decrease), and a strip is more bearish (used by a trader who considers a decrease more likely than an increase).<ref name="Hull 2006 options 234-236"/> |
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For example, an investor with a [[capital gain]] manipulates investments to create an artificial loss from an unrelated transaction to offset their gain in a current year, and postpone the gain till the following tax year. One position accumulates an unrealized gain, the other a loss. Then the position with the loss is closed prior to the completion of the tax year, countering the gain. When the new year for tax begins, a replacement position is created to offset the risk from the retained position. Through repeated straddling, gains can be postponed indefinitely over many years.<ref name="book">{{cite book|last = Brabec|first= Barbara|authorlink=|title=How to Maximize Schedule C Deductions & Cut Self-Employment Taxes to the BONE -|publisher=Barbara Brabec Productions |date=Nov 26, 2014 |location=| pages=107|isbn= 978-0985633318|doi=|id=}}</ref> |
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==See also== |
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* [[Butterfly (options)]] |
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* [[Strangle (options)]] |
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==References== |
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==Further reading== |
==Further reading== |
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{{Library resources box |
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*[http://www.irs.gov/pub/irs-pdf/p17.pdf Publication 17] Your Federal Income Tax |
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*[http://www.irs.gov/app/picklist/list/formsInstructions.html?value=1040&criteria=formNumber&submitSearch=Find Form 1040] series of forms and instructions |
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*[http://www.ssa.gov/pubs/EN-05-10536.pdf Social Security's booklet] "Medicare Premiums: Rules for Higher-Income Beneficiaries" and the calculation of the Social Security MAGI. |
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* {{cite book |
* {{cite book |
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| last = McMillan| first = Lawrence G. |
| last = McMillan| first = Lawrence G. |
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| isbn = 978-0-7352-0465-2 |
| isbn = 978-0-7352-0465-2 |
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{{Derivatives market}} |
{{Derivatives market}} |
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[[Category:Options (finance)]] |
[[Category:Options (finance)]] |
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[[Category:Taxation in the United States]] |
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[[Category:Fiscal policy]] |
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Latest revision as of 14:29, 6 February 2024
 | This article includes a list of general references, but it lacks sufficient corresponding inline citations. (March 2016) |
In finance, a straddle strategy involves two transactions in options on the same underlying, with opposite positions. One holds long risk, the other short. As a result, it involves the purchase or sale of particular option derivatives that allow the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement.
A straddle involves buying a call and put with same strike price and expiration date. If the stock price is close to the strike price at expiration of the options, the straddle leads to a loss. However, if there is a sufficiently large move in either direction, a significant profit will result. A straddle is appropriate when an investor is expecting a large move in a stock price but does not know in which direction the move will be.[1]
A straddle made from the purchase of options is known as a long straddle, bottom straddle, or straddle purchase, while the reverse position, made from the sale of the options, is known as a short straddle, top straddle, or straddle write.[2][3]
Long straddle
[edit]
A long straddle involves "going long volatility", in other words purchasing both a call option and a put option on some stock, interest rate, index or other underlying. The two options are bought at the same strike price and expire at the same time. The owner of a long straddle makes a profit if the underlying price moves a long way from the strike price, either above or below. Thus, an investor may take a long straddle position if he thinks the market is more volatile than option prices suggest, but does not know in which direction it is going to move. This position is a limited risk, since the most a purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential.[4]
For example, company XYZ is set to release its quarterly financial results in two weeks. A trader believes that the release of these results will cause a large movement in the price of XYZ's stock, but does not know whether the price will go up or down. He can enter into a long straddle, where he gets a profit no matter which way the price of XYZ stock moves, if the price changes enough either way. If the price goes up enough, he uses the call option and ignores the put option. If the price goes down, he uses the put option and ignores the call option. If the price does not change enough, he loses money, up to the total amount paid for the two options. The risk is limited by the total premium paid for the options, as opposed to the short straddle where the risk is virtually unlimited.
If the options are American, the stock is sufficiently volatile, and option duration is long, the trader could profit from both options. This would require the stock to move both below the put option's strike price and above the call option's strike price at different times before the option expiration date.
Short straddle
[edit]
A short straddle is a non-directional options trading strategy that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date. The profit is limited to the premium received from the sale of put and call. The risk is virtually unlimited as large moves of the underlying security's price either up or down will cause losses proportional to the magnitude of the price move. A maximum profit upon expiration is achieved if the underlying security trades exactly at the strike price of the straddle. In that case both puts and calls comprising the straddle expire worthless allowing straddle owner to keep full credit received as their profit. This strategy is called "nondirectional" because the short straddle profits when the underlying security changes little in price before the expiration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call.
The risk to a holder of a short straddle position is unlimited due to the sale of the call and the put options which expose the investor to unlimited losses (on the call) or losses limited to the strike price (on the put), whereas maximum profit is limited to the premium gained by the initial sale of the options. Losses from a short straddle trade placed by Nick Leeson were a key part of the collapse of Barings Bank.[5]
Straps and strips
[edit]
Straps and strips are modified versions of a straddle.[6] Whereas a straddle consists of one put and one call at the same strike price, a strap consists of two calls and one put at the same strike price, while a strip consists of one call and two puts. Like a straddle, a strap or a strip allows the trader to profit from a large move in either direction, but while a straddle is directionally neutral, a strap is more bullish (used by a trader who considers an increase more likely than a decrease), and a strip is more bearish (used by a trader who considers a decrease more likely than an increase).[2]
See also
[edit]References
[edit]- ^ S, Suresh A. (2015-12-28). "ANALYSIS OF OPTION COMBINATION STRATEGIES". Management Insight. 11 (1). ISSN 0973-936X.
- ^ a b Hull, John C. (2006). Options, futures, and other derivatives (6th ed.). Upper Saddle River, N.J.: Pearson/Prentice Hall. pp. 234–236. ISBN 0131499084.
- ^ Natenberg, Sheldon (2015). "Chapter 11". Option volatility and pricing: advanced trading strategies and techniques (Second ed.). New York. ISBN 9780071818780.
{{cite book}}: CS1 maint: location missing publisher (link) - ^ Barrie, Scott (2001). The Complete Idiot's Guide to Options and Futures. Alpha Books. pp. 120–121. ISBN 0-02-864138-8.
- ^ Monthe, Paul. "Stories - How Nick Leeson caused the collapse of Barings Bank". Next Finance.
- ^ "Strap Explained". www.theoptionsguide.com. Retrieved 5 January 2022.
Further reading
[edit]- McMillan, Lawrence G. (2002). Options as a Strategic Investment (4th ed.). New York : New York Institute of Finance. ISBN 978-0-7352-0197-2.
- McMillan, Lawrence G. (2012). Options as a Strategic Investment (5th ed.). Prentice Hall Press. ISBN 978-0-7352-0465-2.
