Long straddle

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Long straddle발음듣기

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Let's say that company ABCD is some type of a pharmaceutical company that has a drug trial coming out.발음듣기

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And you're convinced - it's right now trading at $50 a share - but you're convinced that if the drug gets approved, that the company's stock is going to skyrocket.발음듣기

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And you're also convinced that if the drug gets rejected, that the stock price is going to tank to maybe $5 or $10.발음듣기

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So if you wanted to make money off of that belief, and I'm not necessarily recommending that you do.발음듣기

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It's always trickier in reality than it sounds on paper.발음듣기

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But one way that you could is you could actually buy both the call option and the put option on that stock.발음듣기

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The put option is going to make you money if the stock tanks.발음듣기

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And then the call option is going to make money if the drug gets approved and the stock skyrockets.발음듣기

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So let's actually draw the payoff diagram here.발음듣기

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So if the stock goes down, let's say it goes down to 0, you would exercise the put option.발음듣기

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Because you could buy the stock for zero, exercise your put option, and sell it for $50.발음듣기

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This is the right to sell the stock for $50.발음듣기

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And of course, we're talking about the value of the combination now at expiration.발음듣기

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So the stock is worth zero at expiration, the value of the put option is worth $50.발음듣기

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The call option is clearly worthless.발음듣기

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You wouldn't exercise the call option if the stock is worth zero.발음듣기

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You would want to buy something for $50 that's worth 0.발음듣기

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So from the stock's being worth zero, all the way up to the stock being worth $50, you would want to exercise the put option.발음듣기

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But the value of the put option is going to become lower and lower and lower.발음듣기

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And anything above $50, you wouldn't exercise the put option at all.발음듣기

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But if you get above $50, you would want to exercise your call option.발음듣기

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If the stock is worth $60 at expiration, then your call option is worth $10.발음듣기

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Because you have the right to buy something for $50, which you can sell for $60.발음듣기

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So then you have the value of your call option going up.발음듣기

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So you can see a situation here.발음듣기

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When you just think about the value of this bundle of the call plus the put option.발음듣기

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That it's not much value if value of the stock doesn't change from $50, your options are worthless.발음듣기

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But if you have a major movement, either to the upside or the downside, then this straddle, it's called.발음듣기

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Let me write that down.발음듣기

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When you go long a call and you go along a put, this is call a long straddle.발음듣기

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In a long straddle you benefit from a major price movement.발음듣기

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And when you think about it from the profit and loss point of view, you just shift it down based on the amount you paid for the two options.발음듣기

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So in this case, we paid $20 for both options.발음듣기

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So in this situation where we would exercise the put, instead of making $50, we have to net it for the $20 we paid for the options.발음듣기

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So we would only make $30.발음듣기

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And at the point where we're not exercising either option, because they're both essentially worthless, no reason to exercise them, then we essentially have just lost $20 for both options.발음듣기

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So we will be down over here.발음듣기

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And then anything above $50, will start to make money.발음듣기

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So let me draw the option diagram over here.발음듣기

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It will look like this, the payoff diagram.발음듣기

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It will look just like that.발음듣기

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So when you actually factor in how much you paid for the options, you now see that you only would make money with this straddle if the underlying stock price, maybe after the results of the trial are released, hopefully get released before the maturity of the actual options.발음듣기

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If the stock goes below $30, or if the stock goes above $70.발음듣기

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But if it has one of those major movements, then this position, this straddle, this long straddle will make you money.발음듣기

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