Straddles are an interesting strategy, and they are also one with far more risk than some of the other options strategies. Straddles are designed for investors who think that an underlying stock will undergo a large change in price but are not sure if the price will go up or down. Therefore, the investor will purchase both a call and a put option with the same expiration date and strike price.
As long as the stock changes price significantly, the investor will make money on this strategy. However, if the price does not change by enough, then this is a losing market strategy. Therefore, it is only recommended that you try this type of investment if you have enough market experience to be able to predict when stock is going to move by a lot. It is also generally recommended that you not use this strategy unless the stock market is extremely volatile – so volatile that it makes other strategies no longer viable.
If the stock ends up at your strike price in this strategy, for instance, then you will end up losing the maximum amount of money. In this case, however, you will not be losing money on the stock itself, since both of the strike prices are the same. Instead, you will just be losing the money that you spent purchasing the put and call options. Then, you will end up selling stock and buying it back at the same price.
As far as strategies go, this one has a fairly limited price for the risk. If you do not spend too much money on the options, then your losses will be restricted.
However, you should also expect that the amount of money you can make on this strategy will also be pretty limited. This is due to the fact that you will probably not be the only person who realizes that the stock market is highly volatile. Therefore, chances are good that you’ll end up paying higher prices for the options to begin with.
As a result, you should only consider the straddle strategy if you are almost certain that the stock price will change significantly before you reach the expiry date of your options.