What is a straddle in equity options?

A straddle is initiated when a trader is uncertain of market direction in a given time frame. It is direction agnostic and seeks to benefit the buyer from a sharp move either side. It comprises the simultaneous purchase of a call and put option of the same strike on either stock or index or any other asset . For example , if a trader wants to punt on market direction just ahead of the Union Budget on July 5, he or she buys a call and a put on either the Nifty or the Bank Nifty. Let’s say a trader buys an 11,800 straddle on Nifty options expiring on June 27 . The 11,800 call at closing on Friday was Rs 121 a share (75 shares make one lot) and the 11,800 put cost Rs 94 (figures rounded off). This means he has an outgo (less brokerage and taxes ) of Rs 215 a share or Rs 16,125 at contract level. By expiry, the Nifty should have moved beyond 12,015 or below 11,585 for him to make money. This means Nifty has to move more than 1.8 per cent either side from Friday closing of 11,800 for the trade to be in the money until expiry. In short the value of the straddle should be above Rs 215 by expiry for the trader to be in the money.

Can this be elucidated further?

Assume Nifty expires at 11,500 by June 27. The 11,800 call expires worthless. But the 11,800 put is Rs 300 in the money . So the trader gets Rs 85 (300-215) gross profit .

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However, if Nifty expires at 11,800 the premium paid will shrink rapidly to almost nil .

What is the other benefit of straddle?

It tells you how much buyer or seller ( of a straddle ) is willing to wager on a market rise or fall for an event. Once the event occurs the implied volatility of the options fall reducing their price but if the market movement is sharp either side (delta) the fall in implied volatility is made up .



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