I Love The Straddle

     

     Boy oh boy do I enjoy this strategy. It's a pretty simple concept to learn and

to understand. I have been using it in the game I'm playing and it has worked fairly well for me. I have been using it when I know there is going to be big news announced for a stock. Particularly earnings. Let me try and explain the straddle and the pros and cons with it.

(on the left we can see Tyga and Kylie perfecting the straddle)

     First let me say that it is an options tactic. Which means it can be pretty risky. However, buying options contracts in this way reduces your risk substantially. The idea is that you buy a call and a put with the same expiration date at the same strike price.

Quick reminder:
Buying a call is the thought that the underlying asset price will increase. If you buy an option with a strike price of $100 and the stock price goes to $120, you hold the right to exercise the option and buy the stock at a price of $100 rather than $120.  

Buying a put is the thought that the underlying asset price will decrease. If you buy an option with a strike price of $100 and the stock price goes to $80, you have the right to exercise the option and sell the stock at a price of $100 rather than $80.

Here is an example. Palo Alto Networks released their earnings after market close on the 21st. So that day I went and purchased a call option at a strike of $160 and a put option at the same price of $160. I bought 10 contracts of each and the premium I ended up paying was about $4,500 for the calls and $5,500 for the puts. Their report came out and the price went waaaay down. Like 15% down. When it opened up on the 22nd, or Tuesday, the price was at $140. 

     This is what happened. The call option went to nothing. I lost all of the premium I put into it. BUT. The put option ended up being worth $19,000. So the $19,000 minus the $5,500 premium came out to a profit of $13,500. And then that minus the $4500 that I lost came out to a net of somewhere between $8,000 and $9,000. Thats a pretty lucrative deal in the span of 24 hours. 

     The thing that I like about the straddle is that if the price had gone UP, then I would have made about the same amount. It definitely cuts down on the amount of profit one can make, it also takes away a ton of the downside risk. What if I had only bought the call option? I would have been down the premium and that would be it. 

One other thing to note. I didn't exercise the options in this case. I sold the contracts. There have been studies done that have proven that selling the contracts at the premium gives you a higher payout that actually buying all the shares and then selling them. That's what I did. The put options were worth about 19.00 per share. Remember that there are 100 shares bundled into one contract. So $19.00 * 100 is $1,900. Since I had 10 contracts, $1,900 * 10 is $19,000.

     It's all muddled around, but there are some pros and cons that I mentioned. Not explicitly, but I talked about good and bad. I really like this strategy when big news is going to come out and you think the price is going to be VERY volatile.