A straddle is a volatility bet where you simultaneously long a call at Strike Price 1 and long a put at Strike Price 1. This creates a triangular shaped payoff and profit graph where the reward is based on the volatility of the stock. Traders can also bet against volatility by shorting a call at Strike Price 1 and selling a put at Strike Price 1.

What are its components?

A long straddle has two components:

  • Long put at strike price 1
  • Long call at strike price 1

*(A short straddle can be created by short both the call and put at strike price 1)

When and why should I have a straddle?

You should have a straddle if you expect to see a lot of fluctuation in the underlying asset’s price. Creating a straddle does not infer that you have a specific view on the stock. It simply implies that the trader expects a lot of volatility and executed a strategy to gain something from it.

What is the payoff and profit graph?

What is the break-even point?

The break-even point of a straddle can be defined by finding the stock price where the straddle generates a zero-dollar profit. By adding all contracts and equating it to zero, you should solve for ST. However, there is a possibility where there are two stock prices that can break-even. To find those two points, you should create scenarios to define the payoffs. For example, the payoff when ST<40 and 40<ST.

About Kevin Smith

Kevin is the content manager for Personal Finance Lab and is from Chicago, Illinois. He has a Master's Degree in Economics from Concordia University in Montreal, Canada. In addition to an economics background, he has also built training manuals to prepare finance companies for licensing requirements in mortgage loan origination and insurance sales.