A straddle is an investing technique that uses put and call options of the same stock to try to make money. It involves taking advantage of market volatility in the short or long term, regardless of whether share price goes up and down.
This strategy is probably not a good one for novice investors to try as it involves understanding and keeping track of several market factors at the same time. Keep in mind, but don't mentally angst too much over, the fact that the call and put options you buy (or sell) will have the same strike price and expiration date.
This way you "straddle" the line between a stock price going up or down, and can profit either way: same stock, same time frame.
There are two types of straddles: long straddle and short straddle. You gotta know that a call option is the right to buy shares of stock at an agreed-upon price before a specified expiration date. You pay to buy the option, and that payment is gone whether you exercise the option by buying the stock or not. A put option is the right to sell shares of stock at a certain price before a specified expiration date. You also pay a premium for put options.
Long Straddle: Limited downside; large upside potential. You buy both put and call options on XYZ stock, selling now at $112 per share. Both options have a strike price of $120 and an expiration date of Dec. 20. So far, the straddle has cost you the purchase price of the options. If the stock price doesn't change enough before the expiration date to make exercising either the call or the put options profitable, then you're out that initial cost.
However, you've got the pieces in place to make a big profit if the price changes enough -- up or down. If it goes to $200, you could buy each share for $120 then turn around and sell each for $200.
Short Straddle: Limited upside; large downside potential. You sell both put and call options on MNO stock, both with the same strike price and same expiration date. You profit immediately because you're paid for the put and call options. However, you could lose big time, because you're betting on a small enough change in the stock price that the buyer of your options won't exercise them to your financial detriment.
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