When it comes to trading in the market there are numerous highly effective trading strategies that help the traders succeed regardless of the condition the market is in. All this strategies are quite sophisticated in their design & approach. But there is, however, one somewhat less sophisticated strategy that can prove to be as good as the more sophisticated ones. The strategy we are talking about here is known as a straddle. Straddle requires purchase of one ‘put’ & one ‘call’ in order for it to become activated. Now let us take a look at the different types of straddle that are there.
Types of straddle:
The straddle strategy is achieved by holding the same number of puts & calls with the same strike price & expiration. Basically there are two different types of straddle.
- Long straddle: In the long straddle one needs to purchase a put & call at the same strike price & with the same expiration dates. It is designed to benefit from the market price change by taking advantage of the increased volatility in the market. Irrespective of the movement of the market price, long straddle will have the trader placed in a position where he/she can take advantage of that uncertainty. Therefore, the trader can hope to profit irrespective of the movement in the market. A market can typically move in three different directions – up, down or sideways. In order to succeed in an unstable market, the trader can do two things. He can either pick a side & hope that the market breaks in that direction or the trader can hedge his bets & pick both sides at the same time. Through the purchase of both put & call the trader covers all the direction the market may go in.
- Short straddle: In the short straddle the trader sells both his put & call options at the same strike price & expiration dates. Through this sale the trader gets a premium as profit. But short straddle can only be effective when there is little or no volatility in the market. But if there is great volatility in the market then the premium collected by the trader could be in serious trouble. But as long as there is little or no movement, the trader should be fine. In case, the market moves in any direction, the trader does not only have to pay for any looses he accrues but will also have to return the premium he has received from selling the options.
When does straddle work best?
The straddle strategy will work best if the market is in a sideways pattern or there is pending news, earnings or other announcements or market analysts believe something dramatic is about to happen. The trader can use long straddle when the market is moving sideways. Analysts also have great power to influence market movement through their analysis & predictions. After the actual numbers are released the market can move only in three directions – up, down or sideways. The straddle strategy, if properly used, will enable the trader to take advantage of any kind of movement that may be happening in the market.
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September 15, 2011 | by John Greener |