Strategies are the basic bedrock of a successful options trading journey. Just like the saying “failure to plan equals plan to fail”. Consequently, this means that for any trader to make a profit in options, well-planned strategies must be put in place. One of the most renowned strategies in options is the long straddle strategy.
About Long Straddle Strategy in Options
A long straddle strategy is simultaneously buying a long put and a long call of a specified asset at an equal price and expiration. Traders employ this strategy at specific times in the market and it is significantly triggered by fundamentals (mostly news or events). For instance, if Elon Musk decides to sell all his Tesla shares, that could have an impact on the current price of Tesla stocks.
So if speculation like this goes around, a stock options trader could take advantage of the long straddle strategy, with the anticipation of a strong move either upwards or downwards, by buying a long put and a long call of a Tesla stock at an equal price and expiration date.
Although this strategy is a profitable one, it is not a fail-safe as it has its risks. One of the risks of this strategy is that a trader is anticipating a strong move that might not happen or be as strong as expected. Let us further demystify the concept of long straddle strategy in the next heading.
Long Straddle Strategy: All You Need To Know
The long straddle strategy is a prediction of sentiments and biases about the prices of assets moving strongly in the upwards direction or the downward direction. There is uniformity in the potential profit and the price of the asset as it moves in either side of the market. In professional terms, this strategy means the trader is predicting a significant change from low volatility to high volatility with this depending on the potential release of the “big” news.
Typically, profits are made from calls when there is an upward movement while vice versa in the case of puts, small price movement becomes negligible on either side of the market. This justifies the goal of the long straddle strategy which is to make a profit from a significant move that could happen as a result of strong news or event, on either side of the asset.
A long straddle strategy is used in the preparation of a strong move which is usually a result of the potential release of strong news such as election results and actions from the federal government. This strategy faces uncertainty and trade is done in a sizable range because its bedrock is an assumption about an impending move.
The reason behind this trading psychology is the accumulated anticipation. This reason is what loads up traders’ expectations and consequent upon that, a strong push that acts as a catalyst. Because traders are also unsure as regards the potential price direction of the market, a long straddle strategy is employed to help make a profit in either direction.
Because with every trade taken, there is potential for profits and loss and as such, there are certain risks involved. We will be discussing the risks involved in the long straddle strategy
Risk Associated With Long Straddle Strategy
Strategies are a great way to navigate through the market but they are not loss-proof. Strategies are employed to make your trading experience less stressful while maximizing profit and minimizing losses. A long straddle strategy is for maximizing profit but with this comes inherent risk.
One risk associated with employing a long straddle strategy is the possibility of the market not significantly reacting to the market as anticipated upon the release of the expected news. This risk is further complicated by the increase in the price of call and put options which is a result of pent-up anticipation of the unreleased events and news. Consequently, the cost and price in the execution of a long straddle option strategy become higher than taking one-directional trades if there are no potential news releases.
How Traders Deal With The Risk Associated With Long Straddle Strategy
Professional traders identified the long straddle strategy as a profit-making strategy in options trading. They also identified the risk associated and now, they have identified how to tackle that risk.
Options traders understand that there is an increase in price and cost of executing a long straddle strategy which is borne out of the pent-up anticipation of potential news, the trick they employ to tackle this risk is by raising prices of the underlying asset to about 70%. This is seen as a sufficient cover for the anticipated event or news.
There are two sides to every trade taken- the potential profit and loss. Although the long straddle strategy is an options trading strategy that has proven to be an effective tool for traders, it is important to note that this does not negate the fact that it can also fail. Strategies exist just to help make your trading decisions easier and reduce your chances of losses. Also, trade carefully and understand that loss is part of the game. Invest wisely and understand the options market before you go all in.