Options Strategies

Strategy Number 8 - Long "Straddle"

Market dATA
DJ Index 100 points
Prices
Call 100 $1,000

Put 100 $1,500
Strategy name:

Long "Straddle".

Recommended use of strategy

Expectation of high level of volatility of the DJ Index, but without knowing in which direction. For example, elections are due to take place in one month's time.

you expect that if X is elected President, the DJ Index will go up, whereas if Y is elected President, the DJ Index will go down. In any case, you feel that it is reasonable to assume that the DJ Index will not remain steady after the elections.

Strategy components

Purchasing a Long Call and purchasing a Long Put at and identical strike price

(The strike price should preferably be close to the current DJ Index).

Example: Purchase Long Call 100 at a price of $1,000 and purchase a Long Put at a price of $1,500.

Expenses / Income from building the strategy

Expenditure of $2,500.

Strategy graph:

tbl


Auxiliary table for building the profit line

DJ Index
(Horizontal axis)
(Fixed expenses)/ fixed income Variable income
(Call contribution)
Variable income
(Putl contribution)
Total profit / (loss) 
(Vertical axis)
2+3+4
1 2 3 4 5
50 ($2,500) --- $5,000 $2,500
60 ($2,500) --- $4,000 $1,500
70 ($2,500) --- $3,000 $500
80 ($2,500) --- $2,000 ($500)
90 ($2,500) --- $1,000 ($1,500)
100 ($2,500) --- --- ($2,500)
110 ($2,500) $1,000 --- ($1,500)
120 ($2,500) $2,000 --- ($500)
130 ($2,500) $3,000 --- $500
140 ($2,500) $4,000 --- $1,500
150 ($2,500) $5,000 --- $2,500
 

Strategy analysis:

Source of profit        

We profit from a change in the index:

  • When the index goes up we profit on the Call option.
  • When the index goes down we profit on the Put option.

Source of loss

Cost of building the strategy. The loss is maximized when the index remains steady, and is limited to the cost of purchasing the options.

 

Break-even point     

When the profit from the call option and the profit from the Put option equal the cost of the strategy - $2,500. This occurs when the index is at 125 and at 75.

Strategy Number 8 - Long "Straddle"565Strategy Number 8 - Long "Straddle"