Long Straddle Options Trading: Profit & Loss Calculations: Options, Futures, Derivatives & Commodity Trading

Long Straddle Options Trading: Profit & Loss Calculations

Continuing from Part I of Long Straddle Options Trading article Long Straddle Option Example & Payoff Function, here is part II with Profit and Loss Calculations
What are the breakeven points for the Long Straddle Option ?
Break even points are the points or spots when there is no profit - no loss for the option trader. i.e. they are the points either side of which there is a profit area and a loss area.
Long Straddle Options

Upper Breakeven Point of Long Straddle Option = Strike Price of Long Call + Net Premium Paid
i.e. $50 + $8 = $58
Lower Breakeven Point of Long Straddle Option = Strike Price of Long Put - Net Premium Paid
i.e. $50 - $8 = $42

What is the maximum profit for Long Straddle Option Trading Position?
As we can see from the final net payoff function PINK colored graph for the Long Straddle Option, the maximum profit on the lower side is limited to the ATM strike price less the net option premium paid. This will be achieved when the underlying stock price goes to zero. Hence, on the lower side is limited or capped.

While on the upward side, the maximum profit from Long Straddle Option position is unlimited. As the underlying keeps on rising, so will the profit from the Long Straddle continue to go higher.
Maximum Profit for Long Straddle = Unlimited

Profit from Long Straddle will be achieved when Price of the Underlying stock goes higher than the (Strike Price of Long ATM Call + Net Option Premium Paid) OR when Price of Underlying goes less than the (Strike Price of Long ATM Put - Net Option Premium Paid)

Profit from Long Straddle = Price of Underlying - Strike Price of Long Call - Net Premium Paid
Profit from Long Straddle = Strike Price of Long Put - Price of Underlying - Net Premium Paid

But please note that the option traders must also account for the option brokerage which they pay for entering into & exiting from the Long Straddle positions. You will buy 2 options to enter the Long Straddle, and 2 trades to exit the Long Straddle (or exercise at least one of them). Hence, those brokerage and commissions should also be deducted to get an exact amount of profit value.

What is the maximum loss for Long Straddle Option Trading?
Theoretically, the maximum loss you can suffer on this Long Straddle Option Position is the loss of the net option premium you pay to get into the Long Straddle.

Maximum loss of Long Straddle Option = Net Premium Paid + Option Trading Brokerage while entry + Option Trading Brokerage (at exit or exercise)
Maximum loss will occur when at expiry the underlying stock price ends up at exactly the ATM strike price. Even a 1 point move either way will trigger one of the options to be exercised which might incur more brokerage charges (depending upon your broker).

What are the risks in trading Long Straddle Option ?
Long Straddle is considered to be one of the safest bets in the options trading - however, you must note that you are buying 2 options, so you are at the risk of loosing the entire money you will spend in the hope of getting unlimited profit potential on upside and limited profit potential on the downside.

- Time decay will hurt this Long Straddle position. Hence it is advisable to enter this position with atleast 3 months of expiry and exit when less than a month is remaining since time decay rate is highest in the last month. (See Options Time Decay: Explained with Examples).

- The option trader ends up paying a big price while entering Long Straddle since he/she has to buy 2 ATM call & put options. Since they are ATM options, they have the maximum time decay value which increases the cost of buying Option Straddle. The same factor hurts negatively at the exit since there is less time left to expiry and time value already erodes a lot of profit potential.

- Bid and Ask spread may not always be favorable to the Long Straddle option trader. There may be big wide gaps in the prices of ATM calls and puts both at the time of entry and exit from Long Straddle

Let's head to Tips to Enter & Exit Long Straddle Options Positions
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