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Long straddles

Part of Options: calls and puts. Explained from the basics, one idea at a time.

The short version

A long straddle bets on a big move either way

What if you think a stock is about to move a lot, but you can't tell which way? Say a drug company hears back on a new drug tomorrow. A yes sends the stock up. A no sends it down.

A long straddle covers both. You buy a call and a put on the same stock, with the same strike price and the same expiration. A call is the right to buy, so it pays if the stock jumps. A put is the right to sell, so it pays if the stock drops.

The price is two premiums, one for each option. A premium is what you pay for an option. If the stock barely moves, neither option is worth much at expiration. Your worst case is losing both premiums.

Two slips. A straddle isn't a bet on a rise, because a call alone does that. And it doesn't suit a stock you expect to sit still. A long straddle is a call and a put with the same strike and expiration. It needs a big move, either way.

A straddle has two breakevens

A straddle has two options, so it has two breakevens. Where are they? A long straddle is a call and a put with the same strike and expiration. Say you buy a 50 call for 3 and a 50 put for 2.

First, add the premiums. You paid 3 plus 2, so 5 a share in total. The stock has to move 5 to pay that back. So go 5 each way from the strike. Up, 50 plus 5 is 55. Down, 50 minus 5 is 45.

Your worst case is the stock closing right at 50. Both options expire worthless, and you lose both premiums, $500. Your best case has no ceiling, because the call's gain is unlimited if the stock keeps rising.

The slip is using one premium. With just the call's 3, you'd get 53 and 47, and both are wrong. Add both premiums, then go that far up and down from the strike.

Worked example: Straddle breakevens, worked

  1. You buy a September 70 call for 4 and a September 70 put for 3. Find the breakevens and the maximum loss.
  2. Step one: add the premiums, because you paid both. 4 plus 3 is 7.
  3. Step two: go 7 above and 7 below the strike. The call side breaks even at 77, and the put side at 63.
  4. The maximum loss is both premiums, 7 times 100, or $700. That happens if the stock closes right at 70.

Common mistakes

Straddles cost two premiums

Used only one premium? A straddle has two. Add the call premium and the put premium first. Then go that far above and below the strike.

Try a practice question

A long straddle is the purchase of:

  1. a call and a put with the same strike and expiration
  2. a call and a put with different strike prices
  3. two calls with different strike prices
  4. a put on stock the investor already owns
Show the answer

A. a call and a put with the same strike and expiration

  1. Straddle = one call + one put on the same stock.
  2. Same strike price and same expiration.
  3. Long means the investor buys both.