The option straddle strategy is a rather interesting option trading strategy that will help us to take profits in two diametrical opposed scenarios, allowing us to make money if the market moves or if it does not move at all.

It is a more aggressive version than the strangle option strategy, and it relies on the pure extrinsic value of an option.

In this guide, we are going to take a look a what is a straddle option exactly. We will learn both long and short straddle option strategies, and we will take a look at how to make money on both of them.

What is the option straddle strategy?

The option straddle strategy definition says that in order to open this position, we will need to either buy or sell two At The Money option contracts, a call and a put, simultaneously.

How does an option straddle work?

Depending on the type of option straddle strategy we want to open, there are two ways to configure it.

1. If we buy a long straddle, we will be able to profit from both directions in the market.
2. If we sell a straddle, we will profit from the lack of movement of the market.

Let us take a better look at this…

What is a long straddle option strategy?

The long straddle option strategy consists of acquiring an At The Money put contract and another At The Money call contract simultaneously.

As you can see, the difference with the strangle option strategy is this time, we are not buying the contracts as Out of The Money contracts.

When to use the long straddle option strategy?

We should use this option straddle strategy when we are not sure about the direction of the market, but we expect a very strong move in either direction, just exactly as we used the option strangle strategy.

Even when it seems a very useful strategy, the truth is, long straddle option strategy is not easy to use because we are going to need a powerful movement in the prices to happen so we are able to cover the premium we paid for the At The Money options we bought.

Let us take an even deeper look with an option straddle example so we can understand it better.

Long option straddle strategy example

Let us suppose we are going to open a long straddle over the Starbucks company. The stock price today is at $89.75, and we are expecting a big movement in the stock due to the earning reports that the company is about to publish.

As we are not entirely sure how the general sentiment of the report is going to affect the stocks, we are going to open a long straddle option strategy, so we are confident we are taking part in the movement.

For this reason, we will be buying both At The Money call option and put options whose strike prices are $90. In both cases, the volatility is about 30%, so let us take a look at our free option calculator to discover how much we are going to pay for these two contracts.

Long straddle option strategy: At The Money Call and Put Option

As you can see, in both cases, we are taking a seven days expiration period. In the call option, we will need to pay $1.38, and for the put option, we will need to pay $1.61. So, in other words, to be able to open the long option straddle, we will have to pay $2.99 in total.

Now, we should expect that the earnings reports provide a strong movement in the market. However, to be able to identify how far should the stock price needs to move, the best thing is to take a look at the following Starbucks chart using ProRealTime trading software.

The blue line marked in the chart represent the strike prices of both contracts. The red area is the zone in which we will lose money with this strategy. The green zone indicates the area in which our long straddle strategy will make money.

As you can see, in order to make some money, the stock price has to rise or fall at least $3, which is the premium we paid to open the long straddle option strategy, and that is not a very easy thing to happen.

Long straddle option strategy payoff diagram

To understand a little better how our long straddle option strategy works, the best thing to do is to graph the performance of the strategy with our option profit calculator excel

As you can see, when the expiration date approaches, the value of our option strategy decreases because of the time decay the long At The Money contracts have.

If, before the expiration date, the stock price manages to close up near above the $93 or under $87, we might still make some profits. However, such a movement is hard to see in the near term.

Long option straddle strategy margin requirement

In this case, as we are dealing with long At The Money contracts, the broker is not going to ask us for any margin requirement. In other words, we will be able to open this strategy using a cash account.

The reason is because the highest loss we can achieve is already determined by the money we paid to open the position, and nothing more.

What is the short straddle option strategy?

The short straddle option strategy consists of selling an At The Money put contract and another At The Money call contract simultaneously.

However, in order to do this, we are going to need to have a fairly high amount of money in our account, as we are trading with margin.

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When to use the short straddle option strategy?

We should use this strategy when we are not expecting any strong movement in the market. In other words, this strategy works best when the stock price is flat.

However, we must be cautious. As we are selling two contracts simultaneously, there is always the risk that the stock makes a very strong move in one direction or another, so this could make us face a high-risk situation if we are not aware.

Let us take a look at another example, but now selling a short straddle.

Short straddle option strategy example

Following the previous example with Starbucks stock, let us now suppose we believe that instead of a strong movement in the market due to the earnings report, we expect the price to stay flat.

In these case, we are going to take the exact same trade, but this time, we will open a short straddle option strategy.

Short strangle option strategy: At The Money Call and Put Options

Taking the exact same strike price, when we open this option strategy, we will receive $2.99 instead of paying them. So, for our strategy to fail, the stock price should rise above $93 or fall below the $87 threshold.

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It is exactly the opposite situation we found in the long straddle option strategy. The red is found above $93, and under the $87 threshold, while we will keep the premium the buyer paid us if the stock price remains in the green área.

However, in the red area, the risk is unlimited, as the price could fall or rise much more, but as you can already imagine, this is very unlikely to happen.

Short straddle option strategy payoff diagram

To understand a little better how our short straddle option strategy works, the best thing to do is to graph the performance of the strategy with our option strategy calculator in excel

As you can see, the short straddle option strategy payoff diagram is exactly the opposite we found with the long strategy. In this case, time decay benefits our trade as we are dealing with At The Money options.

In the previous table, you can check the exact values we could expect at the expiration date, which, again, they are the opposite we found in the long option straddle strategy.

Short straddle option strategy margin requirement

In this case, as we are shorting At The Money contracts, our broker will ask us quite a lot of money to let us open the trade. The reason is we must provide insurance that, in the case, we end up assigned, we can pay the buyer the money we have to.

To open this kind of strategy, we are going to need to have a margin account.

Even when it is not very probable that any of the branches of the strategy ends up assigned, the broker will not allow us to open it unless we have the margin necessary. So, if you happen to have a small account, you may not be able to open the trade.

Last words about the option straddle strategy

An option straddle is one of the multiple option trading strategies that allow us to have a multipurpose perspective, depending on the side we choose.

As a buyer, we should use the long option straddle strategy whenever we feel that the market is going to make a very strong move in either direction.

As a seller, we should use the short option straddle strategy whenever we believe the stock price is going to stay in a certain area.

And in that way, we will make better use of the option straddle.