Long Straddle

A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements. This strategy involves buying a call as well as put on the same stock / index for the same maturity and strike price, to take advantage of a movement in either direction, a soaring or plummeting value of the stock / index. If the price of the stock / index increases, the call is exercised while the put expires worthless and if the price of the stock / index decreases, the put is exercised, the call expires worthless. Either way if the stock / index shows volatility to cover the cost of the trade, profits are to be made. With Straddles, the investor is direction neutral. All that he is looking out for is the stock / index to break out exponentially in either direction.

When to Use: The investor thinks that the underlying stock / index will experience significant volatility in the near term.

Risk: Limited to the initial premium paid.

Reward: Unlimited

Breakeven: · Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long Put – Net Premium Paid

Example

Suppose Nifty is at 4450 on 27th April. An investor, Mr. A enters a long straddle by buying a May Rs 4500 Nifty Put for Rs. 85 and a May Rs. 4500 Nifty Call for Rs. 122. The net debit taken to enter the trade is Rs 207, which is also his maximum possible loss.

Long Straddle
Strategy  : Buy Put + Buy Call
Nifty index Current Value 4450
Call and Put Strike Price (Rs.) 4500
Mr. A pays Total Premium 207
(Call + Put) (Rs.)
Break Even Point 4707(U)
(Rs.)*
(Rs.)* 4293(L)

 

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Courtesy – NSE India