There are several trading strategies that traders use to make the most profit possible. Strategies range from sophisticated to fairly easy, with one of the least sophisticated strategies being a straddle option. This type of option handles similar market-neutral objectives with less hassle compared to other strategies.
Here we discuss what a straddle option is and several tips you can use to make the most money possible with the straddle strategy.
What Is the Straddle Option?
A straddle option is a neutral options strategy to take advantage of that requires buying a put option and a call option at the same time for the underlying security. These options are purchased with the same strike price and expiration date.
There are two types of straddle strategies:
- Long straddle: A long straddle is based on the purchase of a call and a put at the same expiration date and strike price. This straddle position lets traders take advantage of the market price change by capitalizing on the market’s volatility.
- Short straddle: This straddle position is when traders sell both a put and a call option at the same expiration date and strike price. Selling these options enables traders to make a profit through the premium collected. Short straddles are only profitable when the market is not volatile.
Straddle options prove highly profitable when the stock rises or falls from the strike price at a higher or lower rate than the premium paid for the stock.
Tip 1: Take Advantage of a Volatile Market
Straddle options thrive in volatile markets, so making a straddle move during a volatile market is ideal. The reason straddle positions do so well in volatile settings is due to the fact that the more the underlying stock increases or decreases from the strike price, the more the total value will be. The best option for volatile markets is the long straddle.
Tip 2: Avoid Short Straddles in Most Situations
Short straddles are typically not as profitable as long straddles unless the trader is well-capitalized. This straddle option exposes traders to similar risk profiles as those seen with naked shorts on stock overnight. For this reason, short straddles are most beneficial for experienced traders who are well-versed in straddle strategies.
Tip 3: Open a Straddle Position When Volatility Is Least Expected
While this may seem contrary to the first tip, it’s actually another great strategy for making money with a straddle option. Opening a straddle position while the market is quiet will give you access to much lower prices than when volatility is anticipated. By opening a straddle position during more mundane times, you’ll be able to make a profit off smaller market moves.
Straddle options are an ideal strategy due to the fact that as long as the underlying stock moves up or down, the profit potential is limitless. Taking the time to get familiar with straddle options and the two types of straddle strategies will equip you with the knowledge you need to effectively use this trading strategy.