What is a straddle and when would you use it?

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AcadiFi · Accepted Answer

A long straddle = long call + long put, same strike K and same expiry T. It profits from large moves in either direction, losing when the stock stays near K. The breakeven points are K - (C+P) and K + (C+P). Example: Pelican Foods stock at $60, ATM call and put both K=$60, T=3 months, call=$2.80, put=$2.60, total cost $5.40. Breakevens: $54.60 and $65.40. Max loss $5.40 (if S_T=$60 exactly). Unlimited upside on the call side; put side capped at K-premium=$54.60. When to use: before a binary event (earnings, FDA decision, merger vote) where a large move is expected but direction is uncertain. Implied volatility typically rises into such events and collapses afterward (vol crush), so the straddle buyer needs the actual move to exceed the priced-in IV. ```mermaid flowchart LR A[Long Call K=60] --> C[Straddle] B[Long Put K=60] --> C C --> D[Profit if big move
either direction] ``` Short straddle reverses everything: profits from stock staying near K, loses on large moves. Very risky due to unlimited loss potential, used by traders expecting mean-reverting, low-vol environments. Gamma is largest near K for long straddles, so they're highly sensitive to realized volatility, which is why they're often called volatility trades rather than directional bets.

What is a straddle and when would you use it?

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