Why Buy a Straddle?

Question

What position is a long straddle, what's its payoff picture, and when is buying one the right trade? When is it the wrong trade even if you correctly predict a big move?

Accepted Answer

A long straddle is a long call plus long put, same strike (usually at-the-money), same expiry. Payoff at expiry: |S_T - K|, a V shape; you profit if the stock ends far from the strike in either direction, losing at most the premium paid. It's a volatility trade, not a direction trade. You're long realized movement and long implied volatility (positive vega, positive gamma, negative theta, you pay time decay for the privilege). Right when: you believe the underlying will move (or implied vol will rise) more than the option market has priced in: e.g. you think the market underestimates an earnings binary, a court ruling, a data release; or vol is simply cheap relative to your forecast of realized vol. Wrong even when a big move comes: - The move was already priced. Before earnings, straddles are expensive precisely because everyone expects movement; the stock can jump 5% and you still lose if the straddle implied 7%. After the event, implied vol collapses ("vol crush") and the options bleed even on a decent move. - The move comes late (theta has eaten the position) or the path chops back to the strike by expiry. The sentence interviewers want to hear, verbatim: "buying a straddle is

Why Buy a Straddle?

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