A straddle is an options strategy in which the investor holds a position in both a call and put with the same strike price and expiration date , paying both premiums. This strategy allows the investor to make a profit regardless of whether the price of the security goes up or down, assuming the stock price changes somewhat significantly.
Thus, this is a neutral strategy, as the investor is indifferent whether the stock goes up or down, as long as the price moves enough for the strategy to earn a profit.
The key to creating a long straddle position is to purchase one call option and one put option.
Both options must have the same strike price and expiration date. If non-matching strike prices are purchased, the position is then considered to be a strangle, not a straddle.
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Long straddle positions have unlimited profit and limited risk. If the price of the underlying asset continues to increase, the potential profit is unlimited.
If the price of the underlying asset goes to zero, the profit would be the strike price less the premiums paid for the options. In either case, the maximum risk is the total cost to enter the position, which is the price of the call option plus the price of the put option.
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The maximum loss is the total net premium paid plus any trade commissions. This loss occurs when the price of the underlying asset equals the strike price of the options at expiration.Investopedia Video: In The Money Options
There are two breakeven points in a straddle position. The first, known as the upper breakeven point, is equal to strike price of the call option plus the net premium paid.
The second, the lower breakeven point, is equal to the strike price of the put option less the premium paid. An investor enters into a straddle by purchasing one of each option. Dictionary Term Of The Day.
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