Eli5: What are straddles in futures and options?

Question

Hi All, I want to know what is a straddle strategy in terms of Futures and options trading ?

I have been reading up on Barings bank for a college presentation and it says that straddle strategy was used. I can’t find a clear explanation for that. Thanks in advance.

In: 3

Answer 1

Not a very ELI5 answer because options can be complicated, but here’s a ELiCollegeStudentWithExperienceWithOptions Answer.

A straddle strategy involves buying a put and a call option on the same underlying security. This strategy makes money when the security price decreases or increases a certain amount, while it loses money if the security stays within a certain range.

For example, imagine you buy a call option and a put option on stock XYZ. Let’s say both of these options are European options (you can only exercise them at the expiration date). Both options expire in 1 month, and have a strike price of $100, and the total cost of both options is $10. There are 3 cases at expiration

​

1. Stock XYZ price is below $90 (let’s say it’s $85)

In this case, exercising the call option will lose you money because it is “out of the money” (no point in buying an stock for more than its market price). However, you make $15 from the put, because you have the right to sell stock XYZ for $15 more than its market price. As such, you make $15 from the exercising the put, and because you’ve paid $10 for the 2 options, your profit is $5. In this case, the further the stock price falls, the more money you make (specifically your profit is strikePrice – currentPrice – costOfOptions)

2. Stock XYZ price is between $90 and $110

Like in case 1, one of the options is worthless or “out of the money”, while the other will make you money if exercised. However, the money you make exercising this option isn’t enough to offset the price you paid for the 2 options, so you lose money.

3. Stock XYZ price is greater than $110 (let’s say $115)

Same as case 1, but the put is worthless and the call will make you money. Exercising the call will make you $15, you paid $10 for the 2 options, so your total profit is $5.

​

As you can see, this simple straddle strategy will make you money only if the underlying security is more than $10 more or less than the strike price. This strategy can be used to make you money if you think the stock price will change a lot, but you are unsure of which direction it’ll move.