Education Topics on Derivatives – Futures and Options (F & O)
Understanding of Straddle Options Trading Strategy
What is Straddle?
A straddle is an Options Trading Strategy which involves simultaneous buying or simultaneous selling of both a call option (CE) and a put option (PE) for the underlying asset with the same strike price and the same expiration date.
Long Straddle
A Long Straddle is an option trading strategy in which a trader simultaneously purchases a call option (CE) and a put option (PE) of the same underlying asset with the same strike price and expiration date. Traders will often use this strategy when they believe the price of the underlying asset will move significantly out of a specific range, but they are unsure of which direction the move will take place. Theoretically, this strategy allows the traders to have the opportunity for unlimited gains. At the same time, the maximum loss from this strategy is limited to the cost of both options contracts combined.
The above concept can be implemented in for formulating the strategies for Nifty and Bank Nifty Options Trading.
So lets us understand with example
Nifty Spot Price: – 16238 (06.08.2021 close price)
So we can create an ATM Straddle
i.e. Buying Nifty 16250 CE Expiry 26th August 2021 at CMP 167.95 & Buying Nifty PE Expiry 26th August 2021 at 155.7
So here net premium paid is
(167.95 X 50 = 8397.5) + (155.7 X 50 = 7785) = 16182.50
Maximum Margin (Premium) required for this Trade is 16182.50
Breakeven for this 15927 – 16573 on expiry day.
So a trader can only make profits on expiry day if it goes beyond 16573 or goes below 15927. Let us have look at the below payoff diagram for the strategy.
So theoretically this strategy gives unlimited profits, however if looked into practically the trader can only make if the underlying assets gives one way strong move. The chance of winning in this strategy is lesser.
So one should have very clear understanding of the technical charts must understand the markets moves trending, range bound, breakout etc for getting the success by using this strategy.
Short Straddle
A Short Straddle is an option trading strategy in which a trader simultaneously writes (selling) a call option (CE) and a put option (PE) of the same underlying asset with the same strike price and expiration date. Traders will often use this strategy when they believe the price of the underlying asset will remain in a specific range. So basically the traders are planning to collect the premium benefit of time value (theta) and a range bound move. At the same time, the maximum loss from this strategy is unlimited if the underlying assets gives one way move.
So lets us understand with example
Nifty Spot Price: – 16238 (06.08.2021 close price)
So we can create an ATM Straddle
i.e. Selling (Call Writing) Nifty 16250 CE Expiry 26th August 2021 at CMP 167.95 & Selling (Put Writing) Nifty PE Expiry 26th August 2021 at 155.7
So here the trader can expect a maximum premium of
(167.95 X 50 = 8397.5) + (155.7 X 50 = 7785) = 16182.50
Maximum Margin required for this Trade is approx 114634
Breakeven for this 15927 – 16573 on expiry day.
So a trader can only make profits on expiry day if it remains range bound between 16573 & 15927. Let us have look at the below payoff diagram for the strategy.
Probability of making profits in this strategy are higher compared to the long straddle, however one should have a clear understanding of market directions.
So from the above example you must have understood the term straddle and the long straddle and short straddle concepts.
The straddles can be created in 3 different ways
ATM (AT THE MONEY) STRADDLE
OTP (OUT OF THE MONEY) STRADDLE
ITM (IN THE MONEY) STRADDLE.
More over very interesting and key factor every trader must understand that the short straddles with adjustments gives much better results and regular income for traders. Most of the professional traders do follow the concept of the short straddle and in case markets gives one directional moves they do adjustments so that even if the markets moves one direction they makes money out from this strategy.
The straddles can also be used for intraday trading with adjustments and which is possible through algo trading so that the traders can make money through the same however the chances of winning depends on the market volatility and range. Consistent running of the strategy is having high probability of wining trades.
Another concept of running multiple straddles during the intraday also makes the traders winning ratios higher such as the traders can create all 3 straddles as mentioned above i.e. ATM, OTM & ITM straddles.
Those who are interested in algo trading on the above mentioned concepts can contact us for software related queries.
Disclaimer : – The Strategy is only for Educational Purpose and not a recommendations to follow.
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