The Straddle: Using Calls and Puts Together To Capture A Big Move
5 stars based on
Now that the basic elements of the call and put option contract are laid out and we have reviewed examples of how each type of contract can be used profitably, it is now time to examine when simultaneously purchasing both a call and put option can be profitable. Again the example below is based on stock options, but the concept is the same with whatever financial instrument is used. The straddle is used if a major move in the stock is anticipated.
This type of stock price movement can happen as a result of an upcoming news event such as an earnings announcement or perhaps the results of an FDA drug trial. The call option benefits if the price goes higher.
The put option benefits if the price goes lower. As will be shown, the price move up or down needs to be large to generate a profit. Our example for the straddle strategy is Google. The example will deal with the earnings announcement on Thursday April 17, The earnings announcement was made after the close.
The April stock option series expired with the close of trading on Friday April 18, If there was a delay in the announcement, there was no time remaining to benefit using the April Contracts. For this reason, the May options series is used in the example. This series would not expire until the 3rd Friday in May. The first determination that has to be made is this: The stock would close at These prices must be multiplied by to provide the actual cost of the options.
This can be thought of as This position provides the straddle buyer with control over shares of Google stock. Since it is impossible for both options to be buy call and put option at the same time at the same time, the stock price has to rise or fall more than In other words, buy call and put option at the same time the call option is in the money, the put option has no intrinsic value.
If the put option is in the money, the call option has no intrinsic value. Therefore to break even, the stock price has to move far enough to cover the premium paid for both options. This is the calculation for the call option side of the position. If GOOG trades between these prices, then the position will not make money.
The maximum that can be lost is the cost of the options. With all of this in mind, what happens to the price of Google and the option values after the earnings announcement?
The earnings announcement came out after the close on Thursday April The price closed that day at What has happened to the option values. The put option has become virtually worthless. The opening price on the put option was 10 cents. It would not be possible for the average retail trader to have achieved a position of this type using just stock.
To be both long and short buy call and put option at the same time stock can not be done in a single retail brokerage account. It must be noted that the straddle requires a large move to be profitable. But as shown, it can be a useful strategy under the right conditions. John Emery has been a professional trader for more than a decade, trading in stocks, options and stock indexes on a daily basis.
A former proprietary trader, Emery has written numerous articles for TradingMarkets over the years on topics ranging from trading basics to his own trading methods and strategies. Emery uses options both to trade and as a risk reduction tool.
At Connors Research, we are using it as an overlay to many of our best strategies buy call and put option at the same time make them even better -- now you can, too. The Connors Group, Inc.