Why does a long straddle have two breakeven prices instead of one?
I understand that a straddle profits from big moves, but I keep forgetting why there are two breakeven values and how to find them quickly.
A long straddle owns both upside exposure and downside exposure around the same strike. Because profit can come from a large move in either direction, the strategy has one breakeven above the strike and one below it.
Take Elm Ridge Stores:
- Long call, strike
55, premium4 - Long put, strike
55, premium3
Total premium paid = 7.
That means the strategy needs expiration value of 7 to break even.
- Upside breakeven =
55 + 7 = 62 - Downside breakeven =
55 - 7 = 48
Between 48 and 62, the move is not large enough to recover the premiums. Outside that range, one of the two options becomes valuable enough to push profit above zero.
If you remember only one rule, remember this one: start at the common strike and move outward by the total premium paid.
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