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Straddle Strategy in Options Trading to Make Money

Posted By On 6/20/2009 09:44:00 AM Under ,

1. One can make money in stock market from options trading provided one understands the significance of volatility in the market. However to be on the safer side and to cash on the impending volatility one can go for a Straddle strategy in Options Trading to make money as here  one buys both a call and put option of a stock. Covering the basic straddle one can buy a Call and Put of a stock with the same expiration date and strike price. For example, one can initiate a straddle on Nifty by buying a July 4500 Call as well as a July 4500 Put. This example is only an illustration and trader has to execute this strategy after due deliberation.

2. One buys both Put and Call as one is not aware about the volatility likely to prevail in the stock due to impending outcome and a few examples are as illustrated which can increase the volatility in stock or index as a whole.
(a) A Law suit is filed against a company and result is expected shortly.
(b) Electoral verdict affects index as a whole as it did in India with an unexpected win by UPA and as a result index was locked in upper circuit and exchange had to be temporarily shut down due to execution of the trigger.
(c) Budget effect on certain companies.
(d) Company results

3. With the help of straddle one is able to state with firmness that stock is going to move violently; however one is not sure of the direction of the move. If the price of the stock shoots up, your Call will be way In-The-Money, and your Put will be worthless. If the price plummets, your Put will be way In-The-Money, and your Call will be worthless. This is safer than buying either just a Call or just a Put. One can understand best straddle strategies through an example given for an emerging market .

4. This strategy will be explained further with an example as stated below:
Initiate a Straddle strategy on the ABC stock. Buy a 65 Call and a 65 Put on ABC, 65 being the closest strike price to the current stock price of 63. The premium for the Call (which is 2 Out-Of-The-Money) is 0.75, and the premium for the Put (which is 2 In-The-Money) is 3.00. So our total initial investment is the sum of both premiums, which is 3.75.

5. Fast forward 2 days. ABC produces excellent results and investors go gung ho with the results and the price jumps to 73. The 65 Call is now 8 In-The-Money and its premium is now 9.00. The 65 Put is now Way-Out-Of-The-Money and its premium is now 0.5. If we close out both positions and sell both options, we would cash in 9.00 + 0.5 = 9.5. That's a profit of 4.75 on our initial 3.75 investment. This figure of profit of 4.75 will be multiplied by the lot size.

Risk Factor
6. If it was that easy people would have had become millionaires executing this strategy; however risk lies in the fact that stock or index fails to move violently and thus as a net result options on both sides i.e. put and call expires worthless due to time decay element and one would lose the premium paid as shown in above example a sum of 3.75 and this figure will be multiplied by the lot size.

7. The bottom line for a Straddle strategy to be profitable, there has to be volatility, and a marked movement in the stock price.
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