Straddle is a derivative option strategy. It may seem simple one but it is not so. The strategy is used when it seems that prices will more probably move from their current level, but the direction it will go is not known. Straddle is similar to strangle. Their difference is that straddles use at-the-money option and the strangles use out-at-the-money option.
A straddle is the option strategy that gives the holder the ability to get profits based on how much the price of the underlying security moves, no matter on which direction the price moves. With this option the investor holds a position in both a call and put with the same strike price and expiration date. A buy of a certain option derivatives is the long straddle and the sale of the option is the short derivative.
A long straddle, known also as buy straddle, is a long call and a long put at the same strike price, expiration time and on the same stock. It is a long call on the higher strike, and a long put on the lower strike on the same stock and in the same expiration. The owner of a long straddle makes a profit if the underlying price moves a long way from the strike price, either above or below. So an investor may take a long straddle position if he thinks the market is not stable and does not know in which direction it is going to move. Long straddle options are limited risk but unlimited profit options that are used when the traders think that the underlying assets will show high volatility in the near time.
A short straddle, known also as sell straddle, is a short call and a short put at the same strike price, expiration time and on the same stock. It is a short call at a higher strike and a short put at a lower strike. Short straddle options are limited risk but unlimited profit options. They are used when the trades think the underlying security will experience little volatility in the near time. The short straddles can be rather risky as the losses are unlimited and the profits may disappear of the stock price moves too much.