What is a long straddle and how is it used in trading?

Long straddle definition

A long straddle is a popular options trading strategy with limited losses and potentially unlimited gains. The best time to use a long straddle is when you expect that an asset is going to have a big move, but you're unsure in which direction. Learn how to trade options with the best online broker.

A long straddle strategy looks to profit from a large change in the price of the underlying asset, either higher or lower. To initiate a long straddle, you buy both a call option and a put option with the same strike price, ideally near or at the money, and which have the same expiry date.

How does a long straddle work?

If you're expecting a big move in the underlying asset, but you're not sure whether that move is going to be higher or lower, you could consider setting up a long straddle.

To set up a long straddle, you simultaneously use a put option and a call option. The strike price of both options is the same and is ideally at the money or as close to it as possible. The call option rises in value from a move higher in the underlying asset, while the put option benefits from a decrease.

A small move is not enough for a long straddle to be profitable because the moves in the put and call options offset each other. For a long straddle to be profitable, you need a very large move in the underlying asset in either direction, as this will move the price of either the call or the put option materially higher.

You would normally set up a long straddle ahead of an expected market-moving event, like an earnings release, an election result or a central bank decision. As the option sellers are likely aware of the upcoming event, the options will be priced higher to factor in the expected increase in volatility. Those higher prices mean you will need an even bigger move in the underlying asset for your long straddle to become profitable.

Your profit potential on a long straddle is unlimited if the underlying asset increases in value. The maximum profit to the downside is if the underlying asset falls to zero. The net profit on the trade is the sum received when you close the position, minus the premium paid for the options. Your break-even level is the combined cost of the two options, plus or minus the strike price.

The key risk to the trade is that the underlying asset may only have a small move that's not enough to offset the costs of the options. Your maximum loss would remain limited to the premium you paid for the options. This happens if, at expiry, the underlying asset closes at the strike price. In such an event, both the put and the call are worthless.

Long straddle example

• A long straddle has limited losses and potentially unlimited profit
• The maximum loss is limited to the total cost of the premium paid. This would only happen if the underlying asset price at expiration equals the strike price of the options
• The maximum profit if the underlying asset increases in price is potentially unlimited. The maximum profit to the downside is if the price of the underlying asset falls to zero

Let's say you think a stock is going to have a big move but you're not sure in which direction. So, you go for a long straddle, buying a call and a put option. In the example above, you can see a 'V shape' – this is the profit and loss profile of a long straddle position.

The strike price for both options is $40. If the stock closes at $40 at expiry, both your call and put option will expire worthless. This is the worst-case scenario. The maximum loss is $400 – the total premium paid – which is the point at the bottom of the 'V'.

Your long straddle position is profitable when the stock price at expiry closes either below $34 or above $46. There is unlimited upside profit potential if the stock price rallies very strongly – the higher the stock price at expiration, the greater the profit made.

Your breakeven points are calculated by the cost of the options plus or minus the exercise price. In this example, the break-even points at expiration are if the stock closes at either $34 or $46. The stock price has moved enough to cover the cost of the options but not enough to make a profit. If the stock price at expiry is between $34 and $40 or between $40 and $46, you will still lose money overall but less than the maximum, as the value of the options at expiry has not covered the total cost of the premium paid.

• The premium paid is $400 – this is your maximum loss
• The strike price is $40 for both the call and put options
• The share price needs to move above $46 or below $34 for the long straddle to be profitable on expiry

Usage with implied volatility

• Implied volatility estimates the expected price movement of an asset over a period of time
• Traders opt for a long straddle to take advantage of an expected increase in implied volatility. Higher implied volatility results in higher option prices. It is theoretically possible that a large move in the underlying asset, regardless of direction, could see both the call and put option increase in value due to the increase in implied volatility. **
• Time decay undermines the returns of a long straddle because the time value of the option decreases daily

How to trade a long straddle with options

1. Do your research about the different markets
2. Decide whether you prefer to trade options via spread betting or CFDs
3. Open a trading account or practise with a free demo account
4. Select your market, exercise price and expiration date
5. Choose your position size, place the trade and manage your risk
6. Trade using spread bets or CFDs

Research your market

UK option traders can choose from a huge number of markets to trade on via our award-winning platform. There are options available on forex, shares, stock indices and commodities. Options give you the right, but not the obligation, to buy or sell an asset at a set price on a set expiry date. They allow you to speculate on the movement of a market without owning the underlying asset. You can trade options using either a spread betting or a CFD account.

Learn about the differences between spread betting and CFD trading.

Trading options via spread-betting and CFDs

Spread betting has certain advantages. You can choose a certain amount per point movement using spread bets. This gives you more control over your position size and currency exposure. Spread bets are popular with traders because all your profits are tax-free, and there is no stamp duty or commission payable.* All spread bets are leveraged, which means you only pay an initial deposit to open the position. However, overall profits are based on the full position size, not your premium size.

Note that when buying call or put options, your risk is limited to the margin you paid to open the position. If you sell options, your risk is potentially unlimited, so you need to carefully manage your risk.

You can also trade options using CFDs – short for 'contract for difference'. Like spread bets, CFDs are leveraged products. This means you don't own the underlying asset, but you're betting on its price movement. Your currency exposure and initial margin will vary according to the contract of the asset chosen.

Similar to spread bets, buying options using CFDs limit losses to the initial margin paid, and selling options can risk unlimited losses. Your wins or losses will depend on the outcome of your prediction. CFDs are popular with traders because you can offset losses on CFDs against profits for capital gains tax purposes.* Therefore, traders often use CFDs to hedge their positions.

Long straddle trading strategy summed up

• A long straddle is set up by buying both a call and put option with the same exercise price and expiration date
• A long straddle has limited losses and potentially unlimited gains
• A long straddle's best use is when you expect the underlying asset to have a huge move but are unsure of the move's direction
• An increase in implied volatility will increase the prices of the options and the profitability of the long straddle

^{1Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK}

^{2https://www.optionseducation.org/strategies/all-strategies/long-straddle}