The idea
A long straddle buys a call and a put at the same strike, usually at the current price. It profits from a big move in either direction: the gaining option must rise by more than the total cost of both.
Traders buy straddles before events that could move the price sharply, such as company results or a central bank decision, when they expect a bigger move than the options are pricing.
Watch it play out
Step by step
The rules
Setup
- An event ahead that could move the price far, and a view that the move will be bigger than the options imply.
Entry
- Buy the at-the-money call and put shortly before the event.
Stop-loss
- The cost of the two options is the most you can lose.
Target
- Sell soon after the event, before time decay and the fall in implied volatility eat the gain.
Filters that help
- Compare the cost of the straddle with the stock's past moves on similar events.
- Avoid it when the expected move is already priced very high.
Why it can work
If the event moves the price further than the market expects, the gain on one side outruns the cost of both. The difficulty is that the market expects a big move too, and prices the options accordingly.
The trade pays when the surprise is bigger than everyone expected, which happens, just less often than option prices imply.
Worked example
A stock at $80 has results tomorrow. The $80 call and put cost $5.20 together, so the stock must move more than $5.20, 6.5%, either way to profit at expiry.
It gaps to $88.90: the call is worth about $8.90, more than the $5.20 paid. Had it moved only to $83, the trade would have lost money, because the options also lose their pre-event premium after the news.
When it works, when it fails
Works best
When the move is much bigger than the market priced, typically on genuine surprises.
Struggles
Most of the time: option prices usually overstate the move, and implied volatility collapses after the event, so even a sizeable move can lose money.
Common mistakes
- Buying a straddle because 'something will happen' without comparing the cost to past moves.
- Holding after the event while the options decay.
- Ignoring the fall in implied volatility once the news is out.
Variations
- Long strangle
- Buying out-of-the-money options instead: cheaper, but needs an even bigger move.
What the evidence says
Evidence: ResearchedPublished studies exist. Results depend on the details and on costs.
Research on option prices has found that implied volatility has usually been higher than the volatility that followed, a gap called the variance risk premium. On average that favours option sellers and works against straddle buyers.
Long straddles can still pay on genuine surprises, but on average buyers have paid more than the moves delivered. Hence researched, with evidence that leans against the strategy.
Questions
- When should I buy a straddle before an event?
- Close to the event, to pay for as little time decay as possible. Buying weeks early means paying for days when little happens.
- Is a long straddle better than guessing the direction?
- It removes the need to guess direction, but costs more than buying one option. You are betting on the size of the move against the market's own estimate.
- What is a long straddle?
- Buying a call and a put at the same strike and expiry, profiting from a large move in either direction.
- What is IV crush?
- The fall in implied volatility after an event, when uncertainty disappears. It lowers both options' prices and is why many straddles lose even after a move.
- How big a move does a straddle need?
- Bigger than the total cost of both options, measured from the strike, by expiry. Before expiry, also enough to beat the fall in implied volatility.