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Trading Strategies Involving Options - Straddle

     A combination is an option trading strategy that involves taking a position in a both calls and puts on the same stock is called straddle. In this series we will describe several options trading strategies which are widely used in the market but the principle can be also implemented in binary options market. These include; straddles, strips, straps, and strangles.

One popular combination is a straddle, which involves buying a European style call and put option at the same time with the same expiry time.

A straddle trading strategy is implemented by the option trader when he is expecting a large move in the stock price or any other underlying asset for that matter. The trader in this scenario do not know which direction the move will be. Consider the investor who thinks that the price of a certain asset, currently valued at $69 on the market, will move significantly in the space of the next three months. The option trader could set up the straddle by buying both, the call and the put option with a strike price not too far from the market price, say $70 and the expiration date set in three months in the future.

Suppose that the call option costs $4 and the put cost $3. If the stock price stays around the market value $69, the straddle strategy costs the investor $7. If the stock price moves to $70, the option trader loses $7 on this straddle setup. This is probably the worst scenario it can happen to any option trader that uses straddle technique. However if the asset price finally moves and advances up to $90, a profit of $13 is made. If the asset price decline to $55, a profit of $8 would be cashed.

The straddle strategy seems no brainier to many at the first glance but it is definitely not. Important thing to remember to any option trader using this technique is; to consider if the price move expected is already priced into the option price or not.

Another derivative of straddle technique is; a top straddle or straddle write is the reverse position. It is created by selling a call and put option with the same strike price and the same expiry date. It is highly risky strategy. If the asset price on the expiration date is close to the strike price, a significant profit can be realized but the loss in case of massive spike in price is unlimited and can result in margin call in your trading account.

The straddle strategy is widely used in the market to speculate and hedge. It can be very much successfully applied into the binary options trading. However, the pricing and the timing need to be further adjusted and tested before the straddle technique could be implemented. Binary options are the fixed payout derivatives and offer "all or nothing" scenario in the intraday trading. The straddle strategy would be a losing one, when the payout is less than the potential loss.

If the binary options trader looks beyond one minute trading, there is an opportunity to profit from the longer expiry binary options by taking advantage of European nature of binary option.

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Posted on 2014-06-22, By: *

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