Question

Knowledgeable option investors rarely buy simple calls or puts, but combine different options in order to tailor their risk/return profile. They may give up some potential return in order to have less risk, etc. Choose one of the following strategies and explain why you would want to use the strategy, how you would do it, and when you would make or lose money. Most of these have both a long and short version.

a. Straddle

b. Strangle

c. Iron Condor

d. Spread

e. Butterfly

Answer 1

a) Straddle - This is a strategy which can be both long and short ,and involves buying both call and put option. This strategy is mainly used when the volatility is very high in the market and investors are indecisive of the direction in which the price would move.

In the long straddle strategy both call and put option are bought with the same strike price and expiration date. The maximum amount of loss which can be made is the premium which is paid. Where as the amount of profit which can be made is unlimited.

I can make money , whenever the market either goes up or goes down very sharply . When the market goes up and the market price is more than strike price , i can exercise call option and when the market goes down and the strike price is higher than market price, i can eexercise put Option.

In the short straddle strategy , we sell both the call and put option , in which loss is unlimited and profit is limited to premium. This is just the opposite of long staddle. And everything else is just vice versa of long straddle.