Long Straddle Options Trading Explained: Example & Payoff Charts: Options, Futures, Derivatives & Commodity Trading

Long Straddle Options Trading Explained: Example & Payoff Charts

Details about Long Straddle Option Trading with Payoff Chart explained with an example
All the options trader across the globe know that one of the simplest and most effective option combination is the Long Straddle Option Trading Strategy. Long Straddle is one of the most popular and heavily traded option combination and works best with a long time to expiry when the option trader is expecting a big move in the underlying stock or index price.
Let's see the details and in-depth analysis of Long Straddle Trading in this series of articles:

What is a Long Straddle Option Trading?
A Long Straddle Option Position is a net BUY (also called net LONG) option position where the option trader purchases 2 options - 1 ATM Call and 1 ATM Put Option. Since there are 2 buys, it is a net debit position which means that the option trader has to pay premium (net outflow) while getting into the trade.
Also note that usually since the ATM call & put are bought, which are known to have the highest time decay value, the net price to be paid is usually high.

In which scenarios is the Long Straddle Option Trading profitable to the trader?
A trader should take the Long Straddle Option Trading position only when he/she is expecting a good magnitude of price movement in the underlying stock price, but the direction of movement is not clear.
For e.g., taking some random numbers just for explaining - let's say GENERAL ELECTRIC INC (GE) is trading at around $50 per share (the underlying stock price). It has bid for a large value project worth billions of dollars. If it wins the project bid, the company will make big profits and hence the stock price will go up with large move (expected to touch $80 or more).
On the other hand, if GE looses in that project bidding, its stock price may fall to $25 or so, from the current levels of $50.
The project bidding results will come out in 2 months time from now.

Hence, the above case for GE makes it an ideal scenario for an option trader to get into a Long Straddle Option position. Since after 2 months, depending upon the results of the project bid, the GE stock price may move upwards or downwards with big magnitude. An option trader can benefit from such large swings which may happen in either direction.

How to construct the Long Straddle Option Trading position?
A Long Straddle Option Trading position can be constructed or configured by simply buying the SAME strike, SAME expiry Call & Put Options on the same underlying stock or index.
Usually, the strike price selected is ATM (at-the-money) strike price i.e. closest possible to current spot price. (Want to know what is ITM, OTM, ATM in Options? See Moneyness of Options - OTM, ATM, ITM Options)

1) 1 * ATM Long Put
2) 1 * ATM Long Call
Theoretically, here is how it looks:
Long Straddle Options
An example of Long Straddle Option Trading?
Suppose the GE stock price is currently trading at $50 per share. You know that this stock might move either upwards or downwards with big magnitude in the next 2 months time i.e. the stock price may move significantly on either the higher side or the lower side and you take the following positions for creating a Long Straddle Option Trading.
1) Long Put with ATM strike price of $50 bought at the price of $4 &
2) Long Call with ATM strike price of $50 bought at the price of $4

Since there are 2 buys, the total price you pay is $4 + $4 = $8 (net debit).

Payoff function for Long Straddle Option Trading

Here is the payoff function for Long Straddle Option without the price being considered:
Long Straddle Options
Now, let's add them up together to get the NET ORANGE colored payoff function of Long Straddle Option - note that price is still not considered:
Long Straddle Options

Related: Video Tutorial Long Straddle Option Trading

Finally, let's make the adjustment for the net price of $8 you paid to construct this Long Straddle Option and here we get the PINK colored final net payoff function for Long Straddle Option with price factored in:
Long Straddle Options

Now, lets continue to Long Straddle Option Trading Profit & Loss Calculations
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