Sometimes you’re pretty sure a stock is about to move a lot, you just can’t say which way. Earnings, an FDA decision, a big court ruling. A long straddle is built for exactly that: you make money if the stock moves far enough in either direction, and you lose if it barely moves at all.
How a straddle is built
You buy a call and a put on the same stock, with the same strike (usually at the money) and the same expiration.
- If the stock surges, the call makes money.
- If the stock crashes, the put makes money.
- If the stock goes nowhere, both lose value and you can lose everything you paid.
Max profit, max loss and break-even
| Long straddle | |
|---|---|
| Max profit | Unlimited on the upside; on the downside, strike − total premium |
| Max loss | Total premium paid, if the stock finishes exactly at the strike |
| Upper break-even | Strike + total premium |
| Lower break-even | Strike − total premium |
Worked example
Netflix ($NFLX) is at $500 before earnings. You buy a $500 call for $20 and a $500 put for $18, the same expiration. Total cost: $38 a share, or $3,800.
- Break-evens: $538 on the upside and $462 on the downside.
- NFLX jumps to $550: the call is worth $50 ($5,000), a $1,200 profit.
- NFLX drops to $450: the put is worth $50 ($5,000), the same $1,200 profit.
- NFLX stays at $500: both expire worthless and you lose the full $3,800.
In other words, Netflix has to move more than 7.6% just for you to break even. That’s the hurdle every straddle buyer is up against.
When a straddle makes sense
- Earnings reports, where stocks often gap sharply one way or the other.
- Binary biotech events, like trial results or FDA approvals.
- Big scheduled news, such as merger votes, elections or key economic data.
The catch is that everyone else knows about these events too, so the options are priced for a big move going in.
What can go wrong
- Time decay. You own two options, so you’re losing value on both every day the stock sits still.
- High cost. Buying a call and a put at the money is expensive, which pushes the break-evens out.
- Volatility crush. Right after the event, implied volatility usually collapses. If the move is smaller than what the market priced in, you can lose money even though the stock did move.
Tips
- Compare the cost with the expected move. If the straddle costs $38 and the stock usually moves $25 on earnings, the history isn’t on your side.
- Keep the expiration close to the event. You’re paying for the event, not for months of extra time.
- Have an exit plan for both outcomes. Decide in advance whether you’ll sell right after the news or give the trade a few days.
If a straddle looks too expensive, the long strangle uses out-of-the-money strikes to bring the cost down, at the price of needing a bigger move.