Creating Straddles and Strangles in Stock Trading

You can create a straddle when you simultaneously buy a put and a call for the same stock at the same strike price and of the same duration. You build a strangle with a put and a call that usually have the same expiration date but different strike prices.

With a straddle, if the underlying stock moves far enough, you can

• Make large potential profits

  
  



• Keep your losses to the amount of your initial investment

  
  

Say, for example, that you built a straddle based on ABC stock at $50 per share and you bought a July 50 put option at 5 and a July 50 call option at 2. You’d pay the difference between the two, which is 3 points.

If the stock rises to $55 at expiration, your call option would likely be worth more than what you paid for it, and you could make money even if your put expired worthless. If ABC was at $45 at expiration, then your put option should be worth more than you paid for it, and you could make money on it.

If the stock is somewhere between the break-even points of $45 and $55 per share at expiration, you’ll lose money.

The chances of losing all of your money in a straddle are small, but the chances of making money in this strategy when you hold the position until the expiration date also are small.

You want to build straddles on stocks that are likely to be volatile.

Taking small profits in a straddle can cost you money in the long run. You may have to take a few small losses before you hit a big win. This particular gut-wrenching quality about straddle strategy is what makes it more suitable for experienced investors. If you’re interested in straddles, using an experienced options broker/advisor who truly understands this strategy, at least during your early trading experiences, may be your best, well, option.

Strangles work best when the put and the call are out of the money. Strangles are a risky strategy because you can lose money anywhere along the spread, as opposed to straddles where you can only lose money at the strike price.

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Source:http://www.dummies.com/how-to/content/creating-straddles-and-strangles-in-stock-trading.html