⚡ Straddles and strangles: trading the size of the move

🎯 In 30 seconds: A long straddle is a call and a put at the same strike. A long strangle uses a higher call and a lower put. Both make money if the stock moves far enough in either direction, and lose the premium if it does not. Selling them is the opposite bet: you collect the premium and hope for calm, but your possible loss is very large. The price of a straddle tells you how big a move the market already expects, and beating that number is harder than it looks, especially around earnings.

Direction does not matter, size does

Most option trades are about where the stock goes. Straddles and strangles are about how far it goes. You might expect a big move from a court ruling, a product launch, or an earnings report, without knowing whether the news will be good or bad.

You do not get that bet for free. Options on a stock with a known event coming up are priced higher, because every other trader can see the calendar too. This chapter is mostly about that one problem.

Long straddle: the payoff

Same hypothetical $100 stock and 30-day chain as the vertical spreads chapter. Buy the $100 call for $4.00 and the $100 put for $3.70. Total cost: $7.70, or $770.

• Max loss = total premium = $770, if the stock closes exactly at $100.
• Upper breakeven = strike + premium = $107.70.
• Lower breakeven = strike - premium = $92.30.
• Max profit = unlimited on the upside; up to ($100 - $7.70) x 100 = $9,230 if the stock goes to zero.

Long strangle: cheaper, needs a bigger move

Buy the $105 call for $1.80 and the $95 put for $1.80. Total cost: $3.60, or $360.

• Max loss = $360, anywhere from $95 to $105.
• Upper breakeven = call strike + premium = $105 + $3.60 = $108.60.
• Lower breakeven = put strike - premium = $95 - $3.60 = $91.40.

Worked endings for both:

The strangle loses less when nothing happens. The straddle makes more when something does. Which is "better" depends on prices, not on a rule.

The implied move: what the market already expects

The price of the at-the-money straddle is a quick estimate of the move the market expects by expiration. Here, $7.70 on a $100 stock is about 7.7%. Traders call it the implied move.

That number is the bar you have to clear. Buying a straddle is not a bet that the stock moves. It is a bet that the stock moves more than 7.7%. Selling one is a bet that it moves less. The market has already priced in the move it expects, so there is no free side.

The implied move comes from implied volatility (see Implied volatility). When implied volatility is high, straddles are expensive and the bar is high. When it is low, they are cheap and the bar is low.

Earnings and IV crush, worked through

Before an earnings report, implied volatility on short-dated options usually rises, because a jump is coming. Right after the report, the uncertainty is gone, and implied volatility usually falls sharply. Traders call the fall IV crush. It hits every option you own at once.

Hypothetical example. Company X is at $100 and reports earnings after the close tonight. A straddle at the $100 strike expiring in 5 days costs $6.00, an implied move of about 6%. You buy one for $600.

The next morning the stock opens at $104. You were right that it moved. But implied volatility has collapsed. The $100 call is now worth about $4.07, almost all of it intrinsic value. The put is worth about $0.04.

The stock moved 4%. The market had priced 6%. The extra time value you paid for the event evaporated the moment the event was over. For this straddle to profit on the day after, the stock needed to move more than about 6% in either direction.

Short straddles and strangles: selling the calm

Selling a straddle or strangle flips the payoff. You receive the premium up front and keep it if the stock stays near the strike or inside the strikes.

• Short straddle (sell the $100 call and $100 put, receive $7.70): max profit $770 at exactly $100, breakevens $92.30 and $107.70.
• Short strangle (sell the $105 call and $95 put, receive $3.60): max profit $360 between $95 and $105, breakevens $91.40 and $108.60.

Now the losses. If Company X gets a takeover bid and opens at $130, the short straddle loses ($130 - $100 - $7.70) x 100 = $2,230. At $150, it loses $4,230. There is no limit, because there is no limit to how high a stock can go. On the downside, the most you can lose is ($100 - $7.70) x 100 = $9,230 if the stock goes to zero.

Why "unlimited risk" is not just a phrase

• Gaps. Stocks can jump overnight on news. You cannot close a position while the market is shut, and a stop order will fill at the next available price, not your stop price. See Stop losses.
• Margin calls. Selling naked options requires margin. When the stock moves against you, your broker's margin requirement rises at the same time your position loses money. If you cannot add cash, the broker can close your positions at the worst moment. See Margin explained.
• Approval. Brokers usually allow naked option selling only at their highest approval level, for exactly these reasons. See Options approval and risks.
• The win-loss pattern. Short straddles can win most months and then lose several months of gains in a day. That pattern makes a strategy look safer than it is until the day it is not.

If you want to sell premium with a hard floor under your loss, buy wings: a short straddle with protective wings is an iron butterfly, and a short strangle with wings is an iron condor. Both are in Iron condors and butterflies.

Greeks in one paragraph

A long straddle starts with a delta close to zero, so small moves do not matter much. It has positive gamma, which means it gains delta as the stock moves, in whichever direction. It has positive vega, so rising implied volatility helps it and IV crush hurts it. And it has negative theta: every day without a move costs money. A short straddle has the opposite of all four. See The Greeks.

Try it

Find a stock with an earnings date in the next two weeks using the earnings calendar. The day before the report, write down the at-the-money straddle price for the first expiration after the report, and convert it to an implied move (straddle price / stock price). After the report, record the actual move and the straddle's new value. Repeat for five different companies in your trading journal. Count how many times the actual move beat the implied move.

Sources

• Options Industry Council (OIC): Long straddle
• OIC: Long strangle (long combination)
• OIC: Short straddle
• OIC: Short strangle
• OIC: Vega