How to Trade a Straddle
There are two ways that a straddle option can make money. Both involve a volatile move of the underlying stock.
The first is when the options have low implied volatility and the underlying experiences significantly increased volatility. This can happen as a result of news, earnings, or any number of reasons. When a move like this occurs, the volatility of all of the issue’s options increases and premiums go up as a result. In this case, you may be able to close out the position for a profit.
The second is when the stock moves big. In this instance, one of the option legs ends up so far in-the money that the leveraged return on investment kicks in handsomely - enough to cover the cost of the original position and then some.
Remember, time is working against you. This is usually a short-term trade. Get in, get out.
Picking the Right Straddle
Traders typically pick a strike price at the prevailing underlying price.
Since you either need a big price move or increase in volatility to profit, you’ll want to either find:
- A big event like earnings, a news release, or a speculated acquisition
- Options with abnormally low implied volatility, especially around the time of a big news event.
How to Finish
Straddles should not be considered as buy-and-hold option position that you must hold until option expiration. Traders should monitor the gain/loss carefully and be ready to close the position early if warranted. You should generally close both legs of the position to lock in the profit.
*These examples omit the costs associated with trading options, and you'll need to figure that into your overall returns. At Zecco Trading, options commissions are just $4.50 per trade and $0.50 per contract.