Question

Explain how to build an long straddle, what are the purposes of an long straddle strategy? Build a real life long straddle for an American stock of your choice, pull the options contracts and paste them on the answer. Please explain each part of it, what the credit or debit will be for the transaction, include every detail of each option contract you will use to build the long straddle trade.

Answer 1

Suppose the investor buys both a call and a put with the same exercise price on the same underlying with the same expiration. This strategy enables the investor to profit from upside or downside moves. Its cost, however, can be quite heavy. In fact, a straddle is a wager on a large movement in the underlying.

The value of a straddle at expiration is the value of the call and the value of the put: VT = max(0,ST – X) + max(0,X – ST).

The initial value of the straddle is simply V0 = c0 + p0. The profit is VT – V0 or ? = max(0,ST – X) + max(0,X – ST) – c0 – p0. Broken down into ranges, VT = X - ST If ST < X And VT = ST - X if ST >=X.

In our example, let X = 2000. Then c0 = 81.75 and p0 = 79.25. If S T = 2100 , the value of the position at expiration is V T = 2100 ? 2000 = 100 If S T = 1900 , the value of the position at expiration is V T = 2000 ? 1900 = 100 If S T = 2100 , the profit is ? = 100 ? 81.75 ? 79.25 = ? 61 If S T = 1900 , the profit is ? = 100 ? 81.75 ? 79.25 = ? 61

In summary, for a straddle Value at expiration: VT = max(0,ST – X) + max(0,X – ST) Profit: ? = VT – (c0 + p0) Maximum profit = ? Maximum loss = c0 + p0 Breakeven: ST* = X ± (c0 + p0)

As we have noted, a straddle would tend to be used by an investor who is expecting the market to be volatile but does not have strong feelings one way or the other on the direction.