Long Straddle
Risk: medium
Reward: high
General Description
Entering a long straddle entails buying at-the-money calls and puts at the same strike price.
The Thinking
You are not bullish or bearish but you do think a big move is coming soon. If the stock rallies huge, the puts will expire worthless and you will profit from the calls. If the stock drops big, the opposite will be true. But you need a big move; if the underlying stock just sits there, both the calls and puts will rapidly deteriorate in value.
Example
Let's say MMM is trading @ 95. You buy the 95 calls and the 95 puts for $7 each for a total cost of $14. For you to make money, the stock must either drop below 81 (95-14) or rally above 109 (95+14). If the stock closes anywhere between 81 and 109 you will lose money with your max loss occurring at 95. So again, you need a big move one way or the other.
The image below summarizes the trade with a P/L Diagram. |
