The straddle is a binary options trading strategy which is accomplished by holding the same number of calls and puts that have the same expiry date and the same strike price. There are two types of straddle strategy which can be employed by a trader in order to minimise their risk and increase their profits when binary options trading.
Sometimes known as the buy straddle or the long straddle, this strategy is a neutral one that is used in binary options trading, involving the simultaneous purchase of both a call and a put option of an identical underlying asset with the same expiry date and striking price. This strategy is a limited risk, unlimited profit trading strategy which can be used when the investor believes that the asset’s securities are going to experience a lot of volatility in the short term.
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The short straddle is a strategy in which the trader has to sell a call options and a put option with the same expiry date and the same strike price. By selling his options, he can collect the premium as profit, however he can only succeed in the use of this strategy if there is either very little no volatility in the market. Profit opportunities are entirely based on the lack of ability in the market to either go down or up. Should it develop a bias either way, the total premium which has been collected will be in jeopardy.
Any use of the straddle strategy will either succeed or fail depending on the the natural limitations of the overall momentum of the market.
Using the Long Straddle Strategy
This strategy has been designed to help an investor to make profit regardless of where the market goes, whether it moves down, up or sideways. If it moves sideways, the trader may struggle to know if it is going to break to the downside or upside. In order to prepare successfully for the breakout of the market, there are two possible choices: They either choose a side and hope for a break in their chosen direction, or they hedge their bets, choosing both sides at the same time. This is the long straddle. By buying both a call and a put option, the investor can catch the market’s move whichever way it goes. There are however some drawbacks to using this strategy including expense, lack of volatility in the market and the risk of loss. When buying options, it is important to remember that at the money and in the money options will be more expensive than those which are out of the money, therefore the cost of catching the market’s move may not be able to match the sum at risk. The risk of loss can be a problem as the speed with which an investor is able to exit his losing side of the straddle can impact significantly on the profit achieved from this strategy. Should the losses of the option increase more quickly that the option gains, or if the market does not move an adequate amount to make up for the loss, the trade will overall be at a loss. Should the market lack volatility with no movements down or up, the call and put options will both lose value each day. This will continue until the market chooses its direction, or the options will expire without value.
Using the Short Straddle Strategy
Although the short straddle strategy does have a strength, this is its drawback too. Instead of buying both a call and a put, the investor sells a put and a call to make an income from the premium. While this fills the account, benefiting the trader, the disadvantage is that when an option is sold, the investor is exposed to unlimited risk. This will not be a problem if the market makes no movement down or up in price, but should the market choose a direction, the trader must pay for all accrued losses and must also return their collected premium. Their only recourse in this situation is to purchase back their sold options once their value justifies it. If they do not do this, they only have one choice – to hold on until the expiry time.
When Best to Use the Straddle Strategy
A straddle works best if at least one of these criteria is met:
- The market is moving in a sideways pattern.
- A major news announcement is imminent.
- Extensive predictions have been made by analysts on a specific news release.
Analysts will always make an estimate of how the market will shift a long time in advance of an announcement and this will move the market inadvertently down or up. Whether or not their prediction is correct will be secondary to the reaction of the market and whether the straddle makes a profit.
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