What is a straddle option strategy: understanding this neutral options strategy

Like its counterpart the strangle, the straddle option strategy is hugely popular among crypto options traders because of its neutrality that allows traders to lock in gains from significant price movements, regardless of the direction. Ultimately, this strategy is ideal if you’re expecting a big move in the market but are uncertain whether it will be upward or downward.

Keen to learn how to capitalize on this volatility without having to predict the specific direction of the price swing? From explaining what straddles are to planning and executing your own straddle option strategy in the crypto options space, here’s everything you need to know when it comes to mastering the straddle option strategy.

TL;DR

• Straddles are neutral options strategies involving buying both call and put options with the same underlying asset, strike price, and expiration date.

• The ultimate goal of a straddle is to benefit from a significant price move, regardless of direction.

• Potential straddle gains are unlimited if the asset price moves significantly in either direction.

• Risk-wise, losses from executing a straddle are limited to the total premiums paid for the call and put option contracts.

• Implied volatility and time decay can significantly affect straddle performance.

What are straddles?

Also known as long straddles, straddles are neutral options strategies that involve simultaneously buying both put and call options. Specifically, they involve option contracts for the same underlying asset, strike price, and expiration date. You can choose a long straddle strategy or a short straddle strategy, depending on your expectations regarding market performance.

While simple in theory, the planning and execution of a straddle option strategy seem to be the more complex parts. Crypto options traders often use straddles when they expect incoming volatility. They then select it based on their perceived outlook of the underlying coin or token’s performance.

Given its close ties to volatility, a straddle is the most effective for highly volatile trading instruments. This makes them ideal for crypto options given the inherent volatility and risk involved with trading crypto.

How does a straddle work?

Let’s now explore the mechanics of a straddle option strategy and how it works.

Purchase of call and put options

The crypto options trader begins the straddle by simultaneously buying a call and put option. These are typically at-the-money (ATM), meaning the strike price of both contracts is close to the last-traded price of the crypto asset.

Potential gains

The maximum gains involved with executing a straddle are significant on both the upside from the call option and the downside from the put option. If the asset price moves sharply in either direction beyond the combined premium paid for both calls and puts, the trader can start to realize gains

Potential losses

Unlike other credit-based options strategies, the maximum loss of a straddle is limited to the total premium paid for the call and put options if the asset price doesn’t move significantly by the time the options expire. If the price stays near the strike price, neither option will be exercised, and the trader loses the premium spent on both contracts, as they potentially become worthless.

Break-even points

There are two break-even points in a straddle. On the upside, it's the sum of the strike price plus the total premium paid. On the downside, it's the strike price minus the premium. The price must move beyond these price points for the strategy for options traders to break even.

In essence, the straddle strategy is a bet on market volatility, where the direction of the movement is less important than the magnitude. Traders typically employ this strategy during events that could trigger sharp price swings, such as earnings announcements, regulatory updates, or macroeconomic data releases in the case of cryptocurrencies.

Short straddle options strategy

As the opposite of the conventional straddle options strategy, the short straddle is a strategy that involves calls and puts with the same asset, expiration dates, and strike price. However, this time, both the call and the put are short. A short straddle strategy is commonly used when the trader expects a weak price reaction to a certain event. The risk is the opposite of the one in a long straddle, as you can’t have the market react strongly. Since the risk of loss is quite high, it’s typically reserved for more advanced crypto options traders who have a higher risk appetite. As such, we’ll be focusing on the long straddle for the remainder of this options strategy guide.

Pros and cons of the long straddle strategy

The impact of implied volatility (IV) and time decay

Implied volatility and time decay are two factors that can significantly affect your straddle strategy.

Let’s start with IV. As one of the most important concepts to understand if you're new to options trading, IV can critically determine the successful execution of a long straddle options strategy. In short, IV indicates how volatile the market could become in the future. As such, it's used for setting up an expiration date for your options contracts. Apart from that, it’s also very useful in probability calculation. IV is crucial in accurately assessing how the underlying asset might move by a certain date.

The other factor worth taking into account is time decay. As the Theta portion of the Option Greeks, time decay allows you to measure the rate of the option contract’s drop in value over time. Typically, time delay speeds up in the last month prior to expiration. There's an exception to the rule, which happens when the option is in-the-money (ITM). If the option is ITM, the contract can retain some of its value even as the contract approaches its expiration date because it now has intrinsic value.

Example of a long straddle options strategy being executed

Source: TradingView

For our long straddle example, we’ll be referring to ETH and contracts with expiry dates of October 4, 2024. After using the fibonacci retracement tool and referring to the Relative Strength Index indicator, we can see that Ether has been trading in a consolidated range for the past couple of days. As such, we can take advantage of this range-bound movement by making a bet on a breakout past the $2,557.71 and $2,084.69 price levels.

To set up the long straddle options strategy, we can consider the at-the-money $2,350 call and put contracts. At the time of writing, the total premiums will cost us about 0.112 ETH, or $263.

Now, let's break down how the strategy works. If Ether's price experiences a significant breakout in either direction, we stand to make some gains on this long straddle. On the upside, if ETH rallies beyond the break-even point of $2,613, the value of the call option will increase, allowing us to make some trading gains as the price rises. Conversely, if Ether drops sharply below the lower break-even point of $2,087, the put option will rise in value, and we can lock in some gains from the downside movement.

The goal with this long straddle is to capitalize on a sharp price move, whether it's upward or downward, as long as the move is large enough to cover the cost of the premiums. However, if Ether remains in its current range and doesn't break out significantly by expiration, we risk losing the $263 premium we paid.

This strategy is ideal when we expect heightened volatility, but are uncertain about the direction of the price movement. In this case, given the technical indicators and consolidated price action, a breakout seems likely, which could make the long straddle a potentially lucrative play.

Similar crypto option trading strategies to consider

Beside multi-legged crypto options strategies like the ones we just covered, there are a great number of available strategies out there for budding crypto options traders to try out. Here are several examples to consider.

Naked puts

In contrast to the cash-secured put strategy, where traders set aside funds to purchase the underlying asset, the naked put strategy involves selling a put option without owning the asset or holding a short position. By doing so, the trader takes on the obligation to buy the underlying asset at the strike price if the option is exercised, typically when the market price falls below the strike price. The trader collects a premium for writing the option, aiming for the option to expire worthless if the asset’s price remains above the strike price. This would allow the trader to keep the premium as gains. However, this approach carries significant risk. If the asset's price drops sharply, the trader may be forced to buy it at the higher strike price, leading to substantial losses. As a high-risk strategy, naked puts are generally used by advanced traders who are bullish on the asset or seeking to generate income from the premium.

Covered calls

Another popular strategy among crypto options traders is the covered call option strategy, which involves selling call options on assets you already own. In this case, you hold the underlying asset and sell a call option tied to it. This approach allows you to hedge your long position by setting a higher strike price than the current market value. If the option expires without being exercised, you keep the premium as an additional gain. By selling covered calls, you can generate extra income while holding the asset, capitalizing on the premium without needing the asset's price to rise significantly.

Final words and next steps

The straddle options strategy is a powerful tool for crypto options traders looking to lock in some gains from significant price movements without needing to predict the direction. Whether the market rises or falls, the straddle provides an opportunity to capitalize on volatility because of its neutral nature. However, as with any strategy, it comes with risks. This is primarily the potential loss of the premium if the market remains range-bound. Understanding the mechanics of straddles, such as break-even points, the impact of implied volatility, and time decay, is essential for successful execution. As demonstrated in our ETH example, careful planning and a solid understanding of market conditions can make the long straddle an effective way to navigate uncertain or volatile markets.

Keen to give crypto options trading a try? Find out more by reading our guide to the top platforms for trading crypto options. Alternatively, you can visit OKX for all your crypto options trading needs.