Straddle

A straddle, also called a long straddle or a buy straddle, is an options trading strategy that makes a limited loss if the movement in the price of the underlying is small, but makes a profit (often large, theoretically unlimited) from a large movement in the underlying.

A straddle is a simply strategy consisting simply of buying call and put options with the same underlying, strike price and expiry.

The worst possible outcome for a straddle is that the price of the underlying at expiry is the exercise price. In this case both options expire worthless (at the money), so the total price of both is lost.

More generally, the return on the position is the difference between the price price of the underlying at expiry and the strike price, less the cost of constructing it (i.e. the cost of buying the two options). The greater the movement in price, the greater, in proportion is the profit. The break-even point is a difference equal to the cost.

A straddle is a a bet on volatility that can avoid taking a view on the direction the market will move in. It is worth buying a straddle if you think that the market underestimates volatility. If the market underestimates the volatility of a security, then options on it will be too cheap, because their option value will be under-estimated.

Although a straddle is essentially a market neutral strategy, it is possible for a straddle to be bullish or bearish, depending on the strike price (low strike price is bullish, high is bearish).

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