If you’re new to finance, it’s important to consider the variety of trading strategies you have at your disposal. Several strategies like the straddle option can help you succeed regardless of whether the market rises or falls. Read on to learn more about the straddle option and when to use it.
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How the Straddle Option Works
The straddle option involves concurrently buying a call option and a put option on the same underlying stock with an identical expiration date and strike price. Whereas a call option is a contract between a buyer and seller to exchange a security at a set price, a put option is a contract that gives the owner the right to sell a set amount of a specific asset at a certain price within a certain timeframe. With the straddle option, you have the potential to reach an unlimited amount of profit so long as the stock moves sharply enough.
When the Straddle Option Is Profitable
No matter which way the stock moves, you’re guaranteed a profit. However, it’s important to be mindful of the stock price’s movement. Make sure both the call and put option expire at the same time while having the same strike price. The more the underlying stock moves from the chosen strike price, the greater the total value is of both the call and put options. Do your best to avoid a stagnant stock price and watch for when shares rise or fall sharply. This allows you to make a profit regardless of whether the market is on the rise or if the economy is receding.
When the Straddle Option Works Best
If you want to pay less for the position, opt for using the straddle option when the market is quiet. This can save you a lot of money since straddles before a presumed volatile event are often expensive. When you use the straddle option during a quiet market, the stock doesn’t have to move as much to get you a profit. If you find yourself in a volatile market, a long straddle is your best option as it might give you unlimited earnings when the security price moves dramatically.
What the Straddle Option Can Help Determine
The straddle option can help indicate two things regarding the market. The first is the expected volatility of the trading security. You can measure the stock’s expected volatility using the amount in which the stock is expected to rise or fall. The second is the share’s expected trading range by the expiration date. The range is indicated by the option prices. If you want to calculate the range, add or subtract the straddle’s price to or from the stock’s price.
Now that you understand the straddle option, you’re better equipped to put this strategy to use. Make sure to consider all scenarios to gain the most profit in the long run.
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