Long Straddle
Long Straddle
An options strategy involving the simultaneous purchase of a call option and a put option on the same underlying security, with identical strike prices and expiration dates. This strategy profits from significant price movement in either direction and is used when an investor expects high volatility but is uncertain about the direction. Maximum loss is limited to the total premiums paid for both options. Breakeven points occur at the strike price plus total premiums (upside) and strike price minus total premiums (downside). Suitable for sophisticated investors anticipating major price volatility, such as before earnings announcements or regulatory decisions.
An investor expects significant movement in XYZ stock (currently at $50) surrounding an upcoming earnings announcement but is unsure whether the news will be positive or negative. The investor buys a call option and a put option, both with a $50 strike price, paying $3 for the call and $2.50 for the put (total premium: $5.50 per share). If XYZ jumps to $60 on strong earnings, the call profit is $10 minus $3 premium = $7 gain, offset by the $2.50 put loss, for a net profit of $4.50 per share. If XYZ crashes to $40 on weak earnings, the put profit is $10 minus $2.50 premium = $7.50 gain, offset by the $3 call loss, for a net profit of $4.50 per share. If XYZ stays at $50, both options expire worthless and the investor loses the entire $5.50 premium.
Students often confuse long straddles with long strangles (which use different strike prices, making them cheaper but requiring larger moves to profit). Another common error is miscalculating breakeven points: there are two breakevens (strike + total premiums on upside, strike - total premiums on downside). Many also confuse long straddles (buying both options = limited risk) with short straddles (selling both options = unlimited risk). Critical distinction: long straddles want volatility and have limited loss, while short straddles want stability and have unlimited loss potential. For Series 65, remember that straddles are speculative strategies requiring sophisticated investor understanding and high risk tolerance.
How This Is Tested
- Identifying when a long straddle is appropriate based on volatility expectations and directional uncertainty
- Calculating breakeven points for long straddles (strike ± total premiums)
- Determining maximum loss for long straddle positions (total premiums paid for both options)
- Understanding that long straddles profit from significant price movement in either direction
- Comparing long straddles to long strangles in terms of cost, breakeven points, and required price movement
Example Exam Questions
Test your understanding with these practice questions. Select an answer to see the explanation.
David, a 45-year-old executive, has $800,000 in a diversified portfolio and describes his risk tolerance as "aggressive" for a small portion of his holdings. He follows biotech company ABC, which is awaiting FDA approval for a breakthrough drug. The decision, expected within 30 days, will likely cause the stock to move dramatically in either direction. David believes the stock will make a significant move but is uncertain whether approval or rejection is more likely. The stock currently trades at $75. Which strategy is most appropriate for David to speculate on this volatility?
C is correct. A long straddle is the most appropriate strategy for David's situation. He expects significant volatility (large price movement) but lacks directional conviction (doesn't know if approval or rejection is more likely). The long straddle allows him to profit from a dramatic move in either direction. His aggressive risk tolerance, sophisticated investor profile, and ability to risk the premiums make this speculative strategy suitable, especially for a small portion of his portfolio.
A (call only) is inappropriate because it profits only from upward movement (approval). If the FDA rejects the drug and the stock crashes, David loses. This assumes directional conviction he doesn't have. B (put only) has the same problem in reverse: it profits only from downward movement (rejection) and loses on approval. D (short straddle) is highly inappropriate because selling both options creates unlimited loss potential if the stock moves dramatically in either direction. Given that David expects high volatility, selling options would be disastrous. Short straddles profit from stability, the opposite of what David expects.
The Series 65 exam tests your ability to match options strategies to market outlook. Long straddles are specifically designed for situations with high expected volatility but directional uncertainty (earnings announcements, FDA decisions, regulatory rulings). You must distinguish this from directional strategies (single call or put) and understand that long straddles have limited risk (total premiums) making them more suitable than short straddles (unlimited risk) for volatility speculation.
Which statement correctly describes the structure of a long straddle options strategy?
B is correct. A long straddle consists of buying both a call option and a put option on the same underlying security, with identical strike prices and identical expiration dates. This structure allows the investor to profit from significant price movement in either direction while limiting maximum loss to the total premiums paid.
A describes a long strangle (different strikes), which is a related but distinct strategy that costs less but requires larger price movements to become profitable. C describes a short straddle (selling both options instead of buying), which has the opposite risk profile: limited gain potential (premiums received) but unlimited loss potential if the stock moves dramatically. D describes a different strategy entirely (long call + short put = synthetic long stock), not a straddle.
The Series 65 exam frequently tests the precise definition of options strategies. Long straddle = buy call + buy put at the same strike and expiration. This structure is critical to understanding the risk profile (limited loss = total premiums) and profit potential (unlimited in either direction beyond breakevens). Confusing long straddles with long strangles or short straddles leads to fundamental misunderstandings of risk, cost, and suitability.
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Access Free BetaAn investor establishes a long straddle by purchasing a call option and a put option on DEF stock, both with a $60 strike price and the same expiration. The call premium is $4 per share and the put premium is $3 per share. What are the breakeven points at expiration for this long straddle position?
C is correct. Calculate the two breakeven points for a long straddle:
1. Upside Breakeven = Strike Price + Total Premiums = $60 + ($4 + $3) = $60 + $7 = $67
2. Downside Breakeven = Strike Price - Total Premiums = $60 - ($4 + $3) = $60 - $7 = $53
At $67, the call profit ($7) exactly offsets the total premiums paid ($7), while the put expires worthless. At $53, the put profit ($7) exactly offsets the total premiums paid ($7), while the call expires worthless. Above $67 or below $53, the position is profitable.
A ($56 and $64) incorrectly uses only the put premium for downside ($60 - $4 = $56) and only the call premium for upside ($60 + $4 = $64), failing to account for the total cost of both options. B ($57 and $63) incorrectly calculates using individual premiums rather than the sum. D (single breakeven at $60) is incorrect because there are always two breakeven points for a straddle, and at $60 both options expire worthless for a loss equal to total premiums.
The Series 65 exam tests your ability to calculate long straddle breakevens using the formulas: Strike + Total Premiums (upside) and Strike - Total Premiums (downside). Understanding that total premiums from both options must be recovered for breakeven is critical. The stock must move beyond these points for the strategy to be profitable, which helps evaluate whether expected volatility justifies the cost.
All of the following statements about long straddle strategies are accurate EXCEPT
C is correct (the EXCEPT answer). This statement is FALSE. Long straddles are LEAST profitable (actually experience maximum loss) when the underlying stock remains stable near the strike price. If the stock stays at the strike price through expiration, both the call and put expire worthless, and the investor loses the entire premium paid for both options. Long straddles require significant price movement away from the strike price to become profitable.
A is accurate: long straddles are designed to profit from volatility in either direction. A large move up profits from the call, while a large move down profits from the put. B is accurate: the maximum loss is capped at the total premiums paid (call premium + put premium), which occurs when both options expire worthless at the strike price. D is accurate: this correctly describes the structure of a long straddle (buy call + buy put, same strike, same expiration).
The Series 65 exam tests your understanding that long straddles are volatility strategies, not stability strategies. They require significant price movement to overcome the cost of two premiums. Understanding this risk profile helps you distinguish long straddles (want volatility, limited loss) from short straddles (want stability, unlimited loss) and evaluate suitability based on market outlook and volatility expectations.
An investor establishes a long straddle on GHI stock trading at $80 by buying a call and a put, both with an $80 strike and 60-day expiration. The call costs $5 and the put costs $4. Which of the following outcomes would result in a profit for this long straddle at expiration?
1. GHI stock rises to $95 at expiration
2. GHI stock remains at $80 at expiration
3. GHI stock falls to $68 at expiration
4. GHI stock falls to $75 at expiration
B is correct. Only statements 1 and 3 result in profit.
First, calculate the breakeven points:
- Upside Breakeven = $80 + $9 (total premiums) = $89
- Downside Breakeven = $80 - $9 = $71
The position profits if the stock closes above $89 or below $71 at expiration.
Statement 1 is TRUE ($95): Stock at $95 is above the $89 upside breakeven. Call profit = $95 - $80 = $15 intrinsic value - $5 premium = $10 net gain on call. Put expires worthless (lose $4 premium). Total profit = $10 - $4 = $6 per share. Profitable.
Statement 2 is FALSE ($80): Stock at strike price means both options expire worthless. Maximum loss occurs: lose entire $9 premium ($5 call + $4 put). Not profitable.
Statement 3 is TRUE ($68): Stock at $68 is below the $71 downside breakeven. Put profit = $80 - $68 = $12 intrinsic value - $4 premium = $8 net gain on put. Call expires worthless (lose $5 premium). Total profit = $8 - $5 = $3 per share. Profitable.
Statement 4 is FALSE ($75): Stock at $75 is between the $71 downside breakeven and the $80 strike. Put has intrinsic value: $80 - $75 = $5. But after subtracting the $4 put premium and $5 call premium (total $9 cost), the position shows a net loss: $5 intrinsic - $9 total premiums = -$4 loss. Not yet profitable (needs to reach $71).
The Series 65 exam tests your ability to evaluate long straddle profit/loss scenarios at different price levels. Key principle: the stock must move beyond the breakeven points (Strike ± Total Premiums) for profit. Between the breakevens, the position experiences a loss. At the strike price, maximum loss occurs (total premiums lost). Understanding this profit/loss profile is critical for evaluating whether expected volatility and potential price ranges justify the high cost of buying two options.
💡 Memory Aid
Think of a long straddle as betting on a big earthquake but not knowing which direction buildings will fall: You buy insurance for both directions (call = earthquake pushes buildings up, put = earthquake pushes buildings down). You profit from chaos (big price swings in either direction) but lose in calm (if nothing moves, you paid for insurance you didn't need). Maximum loss = double premium (you bought TWO options). Remember: Long Straddle = Long Volatility (wants movement), and Same Strike = Straddle, while different strikes = strangle.
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Where This Appears on the Exam
This term is tested in the following Series 65 exam topics: