With volatility picking up in the financial markets, it's possible you've started to consider buying premium to either speculate or protect your existing portfolio.
Depending on your outlook, and how much risk you are willing to take/accept, that may be a great game plan.
However, if you have been considering long straddles, you may want to review a recent episode of Tasty Bites, which focuses on this precise topic. The information presented on this episode may help you with the decision-making process.
As outlined on the show, a long straddle is always constructed using a long call and a long put of the same strike price and expiration - and usually the strike price is closest to at-the-money (ATM).
A long straddle is effectively a bet that the underlying will move more than expected, that volatility will go up, or both.
One nice feature of long straddles are the known breakevens because the position is of the "defined risk” variety. The maximum loss of a long straddle is the amount you outlay to establish the position (assuming no stock is traded along with it).
The issue for long straddles is that the expected theoretical P/L and associated average win rates aren't that attractive - especially as compared to the opposite position, a short straddle.
The graphic below summarizes the data from a previous tastytrade study conducted on long and short straddles, using data from 2005 in SPY. As you can see, there's a sharp contrast between the two approaches:
The one dimension of a short straddle that isn't captured in the above data is the fact that short straddles are "undefined risk" positions - meaning they theoretically can suffer unlimited losses. The unlimited part is based on the theoretical potential for a stock to go to infinity - which we know in the great majority of instances is very unlikely.
Regardless, it's arguable that every type of position has a point in time which it becomes attractive in the portfolio.
While long straddles don't offer attractive average P/Ls and win rates, a fast-moving market may at times produce the conditions in which a long straddle may be the perfect fit for a given underlying, or as a hedge in your portfolio.
The important thing is that traders understand the advantages and disadvantages of each (and every position for that matter), prior to trade deployment.
If you have questions on long straddles, we hope you'll leave a message in the space below, or reach out to @tastytrade on Twitter or email@example.com at your convenience.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.