Long straddle

Sometimes you are certain something is about to happen and have no idea which way it goes. A judgment, an election result, a set of quarterly numbers.

A long straddle is the position for exactly that. Buy the call and buy the put, same strike, same expiry, and you own the right to profit from a large move in either direction. The cost is that you have paid for two options and only one of them can ever finish in the money — so the move has to be big enough to pay for both.

That is why the position has two break-even points, one on each side, and why its worst outcome is the underlying sitting exactly on the strike at expiry, where both options expire worthless together.

A long straddle is long volatility and short time, in the purest form on the board.

• It is delta-neutral at inception when struck at the money — the call's positive delta and the put's negative delta roughly cancel, so it has no directional view at all.
• It carries the largest gamma and the largest negative theta of any simple position, and for the same reason: both legs are at the money.
• It is long vega twice over. Rising implied volatility helps it even before the underlying moves.

That last property is also its trap. A straddle bought the day before a scheduled event is bought into elevated implied volatility. The event resolves, volatility collapses, and the position can lose money on a day when the underlying moved in the right direction — the vega loss outrunning the delta gain. The workbook's pharmaceutical example, with implied volatility at 70–80 per cent against a historical 15 per cent, describes precisely the premium a straddle buyer would be paying.

The short-straddle is the exact mirror: a limited profit equal to both premiums, unlimited loss in either direction, taken by a trader who expects the underlying to stay put.

Cost (maximum loss) = Call premium + Put premium

Upper BEP = Strike + Total premium
Lower BEP = Strike − Total premium

Profit zone = anywhere outside [Lower BEP, Upper BEP]
Maximum loss occurs exactly at the strike

A stock trades at Rs 6,000. The at-the-money call costs Rs 257 and the at-the-money put Rs 136. Assume a lot size of 100.

Total premium = 257 + 136 = Rs 393 per unit
Per lot       = Rs 39,300

Upper BEP = 6,000 + 393 = Rs 6,393
Lower BEP = 6,000 − 393 = Rs 5,607

The maximum loss of Rs 393 a unit — Rs 39,300 a lot — happens at exactly Rs 6,000, the one price at which both legs die together.

How big a move is required?

393 ÷ 6,000 = 6.55%

The stock must move 6.55% in one direction or the other just to get the buyer his money back. A 5% move, in either direction, still loses:

At 6,300 (+5.0%): net −93 × 100 = −Rs 9,300
At 5,700 (−5.0%): net −93 × 100 = −Rs 9,300

The trader was right that the stock would move 5%, and lost Rs 9,300 for it. That is the straddle in one line: it is not a bet that something happens, it is a bet on how much.

Chapter 17.2 works the long straddle with the 6,000/257/136 numbers above, including the payoff table and both break-evens. Expect a two-break-even computation, a "where is the maximum loss" question — at the strike — and a strategy-selection question that hands you a trader expecting a large move of unknown direction.

• Two break-even points, not one. Missing the lower one throws away half the payoff diagram, and half the marks.
• Both legs are bought at the same strike. Different strikes make it a long-strangle, which is a different (and cheaper) position.
• The maximum loss is at the strike, not away from it. Candidates routinely put the worst case at the extremes, where the position actually makes money.
• Add both premiums for the break-even span, not the larger one.
• Being right about direction is not enough. The move must clear the combined premium, which on the workbook's numbers is 6.55%.
• A straddle bought before a known event is bought at inflated implied volatility, and the collapse afterwards can lose money on a correct call.