4.Strategy3: Practical Application of Straddle Options Strategy

Hello,

In the previous lesson, we learned about the basic concept of the vertical spread strategy and how to implement it using the app. Today, we are going to introduce the third common combination strategy—the straddle options strategy.

1. What is a Straddle Options Strategy?

The so-called straddle options strategy involves simultaneously trading both call and put options with the same expiration date and the same strike price. When implementing a long straddle options strategy, it means buying both call and put options. Since the buyer's loss in options is limited while the potential gains are unlimited, when combining both call and put options, as long as there is significant volatility in the stock price, theoretically, this strategy can be profitable. Therefore, this strategy is suitable for scenarios such as during earnings seasons or the release of important economic data that could impact stock prices. It's particularly useful when it's hard to predict whether the stock price will rise or fall due to the upcoming event, but it's certain that there will be significant price fluctuations.

Here's an example: Let's say the current stock price of AMD is $106. We anticipate a significant price fluctuation in the future. We decided to buy both a call option and a put option with a strike price of $106 that expires on September 1st, 2023. The premium for the call option is $1.76, and the premium for the put option is $1.12. The total cost of this strategy is therefore $2.88.

If the future stock price rises to $109, the call option will be exercised while the put option will be left to expire worthless. The total profit for this strategy would be $109 - $106 - $2.88 = $0.12.

If the future stock price falls to $103, the put option will be exercised while the call option will be left to expire worthless. Again, the total profit for this strategy would be $106 - $103 - $2.88 = $0.12.

It's evident that this strategy can only be profitable when the stock price is outside the range of $108.88 to $103.12 ($106 ± $2.88).

However, if the expectation is for little change in the future stock price, implying a high probability of loss when buying a straddle options strategy, we can choose to implement a short straddle options strategy. This strategy is the opposite of the long straddle; it involves simultaneously selling both call and put options with the same strike price and expiration date.

Let's continue with the example. If we were to sell both the call and put options with a strike price of $106, the maximum profit would be $2.88 which occurs if the stock price finishes at $106 at expiry (the premium received). However, if the stock price goes beyond the range of $108.88 to $103.12 ($106 ± $2.88), the potential loss theoretically becomes unlimited.

2. How to Execute a Straddle Options Strategy Using an App

In practical execution, we can directly use an app to match this strategy with a single click. The app can also calculate the potential profit and loss of the combination. Here's how to operate it:

Continuing with the example, if we want to execute a long straddle options strategy, start by tapping the strategy section at the bottom of the app and then selecting the straddle strategy. This will display all the option combinations for different strike prices. Choose the desired strike price, then select "Buy." The app will automatically calculate the maximum profit, maximum loss, and profit-loss curve for this combination (note that all data in practical application is typically multiplied by 100 due to contract unit considerations, and it includes transaction costs like fees, leading to some deviation from theoretical values).

If you intend to execute a short straddle options strategy, the process is the same. You simply need to switch from "Buy" to "Sell" at the bottom right corner.

Alright, that's all for today's lesson. In the next lesson, we will discuss the practical applications of the strangle options strategy. See you soon!