A long straddle is an investment approach in which the investor purchases a long call and a long put that share the same strike price, expiration date, and underlying asset. The idea is to create an arrangement in which the investor stands to earn a profit regardless of how the value of the underlying asset moves. There is some risk with the long straddle, since if the market is relatively calm and there is no significant movement in the price of the underlying asset, exercising either the put or the call will not accomplish much of anything.
The fanciful name for this type of investment strategy illustrates the position that the investor assumes in order to maximize the potential for earning a return. The combination of a long put and a long call effectively create a situation where the investor can quickly respond to market conditions, no matter which direction the market moves. As long as the value of the underlying asset remains stable, the investor has to do nothing, but remains in a position between the put and call, effectively straddling both options until there is a need to take action.
In choosing to structure a long straddle, the investor is hoping that upcoming events in the marketplace will cause the underlying security of asset to either increase significantly in value, or undergo a period where the price drops considerably. Depending on the nature of that movement, the investor can then either exercise the put or call to make a profit. Once a decision is made about which option to go with, the investor submits the order to a broker who executes the option immediately and earns a commission off the return that is generated.
The ideal environment for using a long straddle is when the investor has reason to believe that significant price swings are likely to occur before the expiration date he or she has in mind. While the investor may be certain that price swings will take place, there may be variables present that could cause that swing to be upward or downward. By using the long straddle approach, the investor is covered in both scenarios. The only real danger for failure is if those anticipated price swings never take place, and the investor ends up paying fees for the two positions but earns little or nothing from the attempt. In situations where the movement of the market is more defined and predictable, employing a strategy other than a long straddle would likely be a better approach.
