What is a straddle?

What is a straddle?

Straddles are options strategies that use both a call and put on the same underlying asset at the same strike price and expiration.

The Straddle strategy involves either buying a call and a put with the same strike price and expiration, or selling a call and a put with the same strike price and expiration. The former is known as a Long Straddle, and the latter is known as a Short Straddle. Long straddles profit from significant price movement in either direction on the underlying asset.

One of the options will expire useless in either case, but the other has significant earning potential-- in fact, this strategy theoretically has unlimited profit potential. The maximum amount at risk on a long straddle is the price paid for the options contracts. The Short Straddle, on the other hand, has limited upside potential and unlimited risk.

The profit is limited to the premium accepted for the contracts. The short-seller hopes that the price stays within the breakeven points so that neither option will be exercised.

If the price moves dramatically outside of this safety zone, the short seller will be forced to cover the position using resources outside of those provided by this strategy. If the underlying is already owned, the call side can be covered. The put, however, will require cash.