The Straddle Trading Strategy

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Straddle Option Strategy – Profiting From Big Moves

Straddle Option Strategy – Profiting From Big Moves

Do you want to catch big moves in the stock market? In this article, we’re going to show you how the straddle option strategy to catch the next big move. If you’re just getting started, we already covered the basic options trading concepts that you need to know.

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The people who are successful at trading over a long period of time share some common characteristics. Number one is they all focus on high probability trade setups. The straddle strategy forex can help you accomplish that.

If you want to invest in a stock, the share of that stock has a probability of 50/50 chance of going up or down. There are only two probable outcomes. Now, stock options trading opens another door of new opportunities.

Many option strategies you can use will not start off with a 50/50 probability. The straddle option strategy is a strategy that can produce a high probability rate of success.

But what is a straddle option strategy?

What is a Straddle Option Strategy?

Understanding the options market can help your approach to trading become much more dynamic. Basically, the straddle strategy is selling a put option and selling a call at the same time. Or buying a put and buying a call option at the same time. In other words, you buy/sell a put and a call at the same strike price and at the same expiration date.

When buying a straddle, we want to stock price to move significantly either up or down. On the other hand, the short straddle options strategy requires the stock price to remain unchanged.

Is an options straddle a good strategy?

Let’s use the example of a stock trading at $50.

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Now, the straddle requires buying (or selling) at the money call option and buying (or selling) at the money put option. To simplify things we’re going to assume that the $50 strike call is worth $1 and the $50 strike put equals a $1 too.

The cost of buying the put option and the call option will be $2. In other words, the straddle call strategy will cost you $2.

In this situation, the put option is going to make you money if the stock tanks. And the call option is going to make you money if the stock price skyrockets.

If the stock goes down to zero, you will exercise the put option and sell the stock for $50. The put option gives you the right to sell the stock for $50. In this case, the call option is worthless. You don’t want to exercise it if the stock is already trading at zero. You wouldn’t want to buy something for $50 that’s eventually worth nothing.

In the case the stock price is trading above $50, you wouldn’t exercise the put option but instead, you would want to exercise your call option.

However, if you believe the stock price will stay in a tight range, between let’s say $48 and $52, we want to use the sell straddle strategy. When the market is going to “sleep” we’re collecting the premium from selling the trade options.

Note* When you buy options you pay the premium. When you sell options you’re collecting the premium.

Straddle Call Strategy

The straddle call strategy gives you the advantage of only taking a fixed amount of risk and higher rewards. This is because the rewards are limited. However, buying straddle has a lower probability rate.

The time is also in favor of the straddle seller.

Note* The person who sells a straddle is going to win most often because the odds are in their favor.

The pay off diagram, factoring in the costs also, will look something like in the figure below:

You will only make money with the long straddle strategy if the underlying stock price goes up significantly.

Moving forward, in this step-by-step guide you’ll learn some tips and other information you need to improve your profitability with the straddle strategy.

Straddle Strategy

Before implementing the straddle strategy you need to make sure you check the four requirements:

  1. Simultaneously buy (sell) a put option and a call option.
  2. The straddle option should have the same underlying stock.
  3. Same strike price.
  4. Same expiration date.

The implied volatility is a big part of an option’s price. The higher the volatility, the more you’ll have to pay for the option. In this regard, the best time to buy a straddle option is when the implied volatility is at its lowest.

When the implied volatility will increase this will benefit your long straddle trade.

Periods of contraction in implied volatility are always proceeded by periods of expansion in implied volatility. When the implied volatility picks up, we’re going to have big moves in price. This will help either the put option or the call option, depending on which direction the stock price goes.

For example, if you look at Teslas’ implied volatility over the last year, we can see that after each period of low activity it has quickly and swiftly moved higher. In this situation, a good strategy is to buy straddle because when the volatility goes up, the Tesla stock price will experience a big move either up or down.

Options with low implied volatility are considered to be cheap options. The cheap options have the advantage of offering small profit losses if you’re wrong on the trade.

Let’s now compare the straddle call strategy or the long straddle with the short straddle strategy.

Let’s suppose the ABC stock is trading at $100. An options trader will enter a long straddle position by buying a Dec 100 put for $4 and a Dec 100 call for $4. The total premium he pays to open the long straddle is $8. This is also the maximum loss he can take.

If at the expiration date, the ABC stock is trading at $120, the Dec 100 put will expire worthless, but the Dec $100 call will expire in the money. In this case, our option trader will make $12 ($20 from the sale of option -$8 from the premium he pays to go long the straddle).

The straddle call strategy will make you money even when the underlying stock price is going down.

If at the expiration date, the ABC stock is trading at $80, the Dec $100 call will expire worthless but the Dec $100 put will expire in the money. In this case, our option trader will still make $12 ($20 from the sale of option – $8 from the premium he pays to go long the straddle).

However, if our option trader will enter a short straddle by selling a Dec $100 put for $4 and a Dec $100 call for $4, he will be collecting the premium of $8 from the option trader who is buying the options.

In this case, for our option trader to make money, he needs the ABC stock price to move no more than $4 in either direction by the options expiration date.

The straddle strategy will likely just be one part of your broader approach to the market. Depending on your current situation, you may want to consider trading RSUs (restricted stock units) alongside ordinary options.

Conclusion – Straddle Option Strategy

In conclusion, you want to use the straddle call strategy or long straddle if you want to benefit from a major price movement.

However, on the other hand, if you believe the stock price is going to be unchanged, you want to use the short straddle options strategy. Selling straddle works best in a volatile environment.

The straddle call strategy has unlimited profit potential and limited risk. The only risk you take is the premium you pay when you use this type of call strategy.

Thank you for reading!

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Straddle

What Is a Straddle?

A straddle is a neutral options strategy that involves simultaneously buying both a put option and a call option for the underlying security with the same strike price and the same expiration date.

A trader will profit from a long straddle when the price of the security rises or falls from the strike price by an amount more than the total cost of the premium paid. Profit potential is virtually unlimited, so long as the price of the underlying security moves very sharply.

Key Takeaways

  • A straddle is an options strategy involving the purchase of both a put and call option for the same expiration date and strike price on the same underlying.
  • The strategy is profitable only when the stock either rises or falls from the strike price by more than the total premium paid.
  • A straddle implies what the expected volatility and trading range of a security may be by the expiration date.

Straddles Academy

Understanding Straddles

More broadly, straddle strategies in finance refer to two separate transactions which both involve the same underlying security, with the two component transactions offsetting one another. Investors tend to employ a straddle when they anticipate a significant move in a stock’s price but are unsure about whether the price will move up or down.

A straddle can give a trader two significant clues about what the options market thinks about a stock. First is the volatility the market is expecting from the security. Second is the expected trading range of the stock by the expiration date.

Putting Together a Straddle

To determine the cost of creating a straddle one must add the price of the put and the call together. For example, if a trader believes that a stock may rise or fall from its current price of $55 following earnings on March 1, they could create a straddle. The trader would look to purchase one put and one call at the $55 strike with an expiration date of March 15. To determine the cost of creating the straddle, the trader would add the price of one March 15 $55 call and one March 15 $55 put. If both the calls and the puts trade for $2.50 each, the total outlay or premium paid would be $5.00 for the two contracts.

The premium paid suggests that the stock would need to rise or fall by 9% from the $55 strike price to earn a profit by March 15. The amount the stock is expected to rise-or-fall is a measure of the future expected volatility of the stock. To determine how much the stock needs to rise or fall, divide the premium paid by the strike price, which is $5 / $55, or 9%.

Discovering the Predicted Trading Range

Option prices imply a predicted trading range. To determine the expected trading range of a stock, one could add or subtract the price of the straddle to or from the price of the stock. In this case, the $5 premium could be added to $55 to predict a trading range of $50 to $60. If the stock traded within the zone of $50 to $60, the trader would lose some of their money but not necessarily all of it. At the time of expiration, it is only possible to earn a profit if the stock rises or falls outside of the $50 to $60 zone.

Earning a Profit

If the stock fell to $48, the calls would be worth $0, while the puts would be worth $7 at expiration. That would deliver a profit of $2 to the trader. However, if the stock went to $57, the calls would be worth $2, and the puts would be worth zero, giving the trader a loss of $3. The worst-case scenario is when the stock price stays at or near the strike price.

Real World Example

On October 18, 2020, the options market was implying that AMD’s stock could rise or fall 20% from the $26 strike price for expiration on November 16, because it cost $5.10 to buy one put and call. It placed the stock in a trading range of $20.90 to $31.15. A week later, the company reported results and shares plunged from $22.70 to $19.27 on October 25. In this case, the trader would have earned a profit because the stock fell outside of the range, exceeding the premium cost of buying the puts and calls.

Forex Straddle Trading Strategies – MT4 Trade Panel Software

Updated: September 21, 2020

Welcome to the Forex straddle trading tutorial with my Metatrader Trade Panel.

If you’re interested in straddle trading, you’ve reached the right place – especially if you’re using Metatrader, where you ideally want a Metatrader app to provide the correct functionality.

The panel has a few pre-programmed straddle strategy templates that you can deploy quickly at the click of a button, while at the same time you remain in full control of what your overall risk will be.

I will walk you through each strategy, their concept, how they work, and what you can do with them.

The Classic Straddle Trading Strategy Explained

The text book definition of a straddle trade is when you place a buy and a sell order at the same time.

This approach is used by a lot of news traders.

They place a buy stop above a technical high, and a sell stop below a technical low – when the news data is announced, they hope to catch a breakout as the market moves through one of the two pending orders.

Essentially you’re ‘trapping’ price with two pending orders, and catching the breakout out of one end of your trap.

The example above shows a buy and sell stop order placed around the outside of a candlestick. This is the classic way to do it.

Now the news trader’s logic would be, if the data comes out good, the market will rally and trigger my buy order, and if it’s bad, then the price will drop and trigger the sell.

Of course there is always the risk with highly volatile events that you get bad whipsawing, throwing the market price up and down dramatically, triggering both orders and stopping them both out before you can blink.

It’s more common than you think.

So I don’t really participate in news trading, and those who I know who have, only have horror stories to tell.

This configuration exposes you to double the risk, because you’ve likely placed the two orders without factoring that into your lot size.

Let’s look at a smarter way to do this…

A More Controlled Straddle Trade Approach With The Panel

We can get a bit more control with our straddle trade by using the OCO functionality on the panel – or more specifically, OCG.

We covered the ‘order cancels order’ types in the previous tutorial. If you’re interested in this, I suggest you stop and read the OCO order tutorial first.

If we want the same kind of straddle order that I demonstrated above, but this time when one order is triggered, the other is canceled – we can do that very easily with the OCG function.

Open the trade panel and do the following:

  • Set the entry strategy to breakout
  • Set stop loss setting to candle high/low
  • Check the ‘Assign Trade To Group’ box
  • Apply a number not in use by any other trades
  • Apply any other settings from the panel you like
  • Press Buy

Now the buy part of the straddle order is placed. To complete it we more or less just press the sell button.

  • Set the panel options exactly how you did for the buy trade component
  • Make sure ‘Assign Trade To Group’ is checked
  • Assign the trade to the same group number as the buy trade
  • Press Sell

Now you’ve got a managed straddle trade set up.

When one of those breakout orders are triggered, the other is canceled by the panel, just like a classic OCO order.

The obvious benefit here is you reduce your risk exposure by allowing only one trade to go live, in contrast to the first example – where you would just leave two pending orders open, and whatever happens, happens.

This configuration only gives you the shot on the one initial breakout you’re triggered into. Sometimes the market will break one way, whip back the opposite way, trigger the other order, and stop them both out.

That’s the scenario we’re trying to avoid with the OCO configuration.

It comes down to what you’re trying to achieve, but you can always exploit the panel’s options to make something work for you.

Stop Out Recovery Straddle Trade Strategies

The panel comes with some pre-set straddle strategy templates which ‘extend’ onto your primary trade configuration.

When you set up a trade on the panel, and opt into a straddle strategy, the panel will open a second order with the straddle strategy applied to it.

These straddle strategies are designed to work like recovery money management ie. If your trade fails, the straddle trade goes live in that moment, and triggers a trade in the opposite direction.

The idea here is to turn a losing trade, back into a winner, without exposing unnecessary risk.

Let’s walk through the straddle recovery strategies that come with the panel…

Straddle Mirror Trade

The mirror trade is the easiest to explain.

After the panel sets up your initial trade, it will then place another trade in the opposite direction, but just flip your entry and stop loss prices.

This means the straddle trade entry price will be located at the same price as your primary trade’s stop out price.

Think about that, it means if your original trade is stopped out, in that same moment, the straddle trade will kick in and go live.

Take a look at the example below.

What I’ve done here is targeted a reversal candlestick pattern – a rejection candle.

I’ve asked the panel to do the classic 50% retracement entry strategy on it, and place the stop below the candle low.

At the same time I asked the panel to place a straddle mirror trade – which as I mentioned above is a trade in the opposite direction built around reversing the stop loss and entry price of your original trade.

So in this case, lets say your buy trade fails, the candlestick pattern doesn’t work and causes you to be stopped out – all the internal rage builds up within you and you want to throw your computer out the window… kidding.

When the buy trade fails, the straddle kicks in, and has the potential to make your loss back, plus potentially some profit – depending on what your target is like.

Normally when a trade fails the market explodes in the other direction.

These straddle strategies are designed to capitalize on moves after losing trades.

Straddle Trade Around A Candlestick

The second straddle option we have is to straddle around the ‘entry candle’.

Meaning, whatever your target candle is set to in your entry strategy options – is what the straddle strategy will use as a frame work for building the recovery straddle order.

The idea is the same as the the mirror trade strategy, we use your original trade’s stop loss as the entry price for the straddle trade, so when your original trade gets knocked out, the straddle trade is triggered.

The only difference between the ‘Use Entry Candle’ and ‘Mirror Trade’ is the way the stop loss is placed.

Mirroring the original trade may provide too aggressive of a straddle stop loss. Like the example with the retracement entry, the stop being placed in the mirror trade version is a little tight.

In this strategy we use the target candle’s high or low for the stop loss placement.

Take a look at the example below.

This is exactly the same trade example as we used before, the only difference is we switched the straddle strategy to ‘use entry candle’.

Notice the only thing that has changed is the stop loss placement, which is now at the entry target candle’s high.

If we were entering a sell trade initially, a buy straddle would be set up with the stop below the low of the target candle.

In this case, the straddle trade is more conservative, providing a more sensible stop loss for the straddle trade.

Same principle, if the original trade idea fails, the straddle trade kicks in and will hopefully make the loss back with it’s returns.

Important Notes About Straddle Trades

What if your original trade works out, is the straddle trade going to sit there forever triggered?

No, the panel will cancel your straddle trade pending order if your original trade hit a 1:2 risk reward profit target.

The logic here is that if your original trade hits 2x, then that trade idea is working out in your favor and there is no need to keep the straddle trade open.

If your straddle trade gets triggered first, but your primary trade hasn’t been triggered yet, what happens?

Well the panel simple deletes the original trade’s pending order. Since the straddle trade got triggered first, that means your original trade idea is invalidated and therefore we can get rid of it, just leaving the straddle trade to go to work.

Once your straddle trade is triggered, you’re free to adjust it’s target price. I wouldn’t recommend adjusting the stop loss or entry price as you will mess up the risk profile, and really the overall structure of how the straddle trade wants to work.

The risk you specified in the risk settings of the panel will be portioned equally into the straddle trade.

If you risk $1000, then $500 will be allocated to your original trade, and $500 to the straddle trade.

This was done to prepare for the ‘worse case scenario’ situation where your trade and the straddle trade get stopped out by whipsawing in the market.

In that event of a double stop out, you will not lose more than you intended. So make sure you keep that in mind when you set up your risk.

Some traders might opt in to double their normal risk. Using the same example, they might tell the panel to risk $2000, so $1000 risk is allocated to your trade, and the straddle trade.

It’s up to you how you want to risk your money, just know the panel will always try to portion what you tell it to risk into all the orders it must open.

Take Home Message

To keep it simple, there are two types of straddle trading approaches explained in this tutorial

  • the classic double breakout order strategy
  • recovery money management geared straddle trading strategies

The panel can accommodate both, depending on what your strategy/goal is. Just use the appropriate features used on this panel to achieve what you need.

Recovery management with straddle trades is a really cool concept that I designed myself. Just make sure you read the tutorial from top to bottom so you know how the panel handles events – especially the ‘Important Notes About Straddle Trades’ section.

If you use these straddle systems. please let me know how it goes for you in your trading, or leave a comment. I hope it does help a lot.

Guys, enjoy the panel and as always – best of luck on the charts!

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