AskDefine | Define straddle

Dictionary Definition

straddle

Noun

1 a noncommittal or equivocal position
2 a gymnastic exercise performed with the legs straddling the parallel bars
3 the act of sitting or standing astride [syn: span]
4 the option to buy or sell a given stock (or stock index or commodity future) at a given price before a given date; consists of an equal number of put and call options

Verb

1 sit or stand astride of
2 range or extend over; occupy a certain area; "The plants straddle the entire state" [syn: range]
3 be noncommittal [ant: side]

User Contributed Dictionary

English

Pronunciation

Verb

  1. to sit or stand with a leg on each side of something
  2. to form a disorderly sprawl
  3. to fire shots in front and behind of a target, especially in order to estimate its range
  4. to place a voluntarily raise prior to receiving cards (only by the first player after the blinds).

Translations

to sit or stand with a leg on each side of something
to form a disorderly sprawl
to fire shots in front and behind of a target

Noun

  1. a posture in which one straddles something
  2. an investment strategy involving trade in derivatives
  3. A voluntary raise made prior to receiving cards by the first player after the blinds.

Extensive Definition

This article is about the financial investment strategy. For other meanings, see Straddle (disambiguation).
In finance, a straddle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement. The purchase of particular option derivatives is known as a long straddle, while the sale of the option derivatives is known as a short straddle.

Long straddle

A long straddle involves going long, purchasing, both a call option and a put option on some stock, interest rate, index or other underlying. The two options are bought at the same strike price and expire at the same time. The owner of a long straddle makes a profit if the underlying price moves a long way from the strike price, either above or below. Thus, an investor may take a long straddle position if he thinks the market is highly volatile, but does not know in which direction it is going to move. This position is a limited risk, since the most a purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential, since the change of the underlying price of any option is unlimited.
For example, company XYZ is set to release its quarterly financial results in two weeks. A trader believes that the release of these results will cause a large movement in the price of XYZ's stock, but does not know whether the price will go up or down. He can enter into a long straddle, where he gets a profit no matter which way the price of XYZ stock moves, if the price changes enough either way. If the price goes up enough, he uses the call option and ignores the put option. If the price goes down, he uses the put option and ignores the call option. If the price does not change enough, he loses.

Short straddle

A short straddle is a non-directional options trading strategy that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date. The profit is limited to the premiums of the put and call, but it is risky if the underlying security's price goes up or down much. The deal breaks even if the intrinsic value of the put or the call equals the sum of the premiums of the put and call. This strategy is called "nondirectional" because the short straddle profits when the underlying security changes little in price before the expiration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call.
A short straddle position is highly risky, because the potential loss is unlimited, whereas profitability is limited to the premium gained by the initial sale of the options.

The collar

The Collar is a more conservative "opposite" that limits gains and losses.

As a volatility strategy

By engaging in a straddle transaction, the investor is also taking a position on the volatility of the underlying security. Going long a straddle is a bet that the underlier will be more volatile over the straddle's term than predicted by the market. Conversely, going short a straddle is a bet that the underlier will be less volatile. To see this, assume that the investor frequently re-hedges his portfolio with the underlier to keep his portfolio delta neutral. Because delta for an option is a monotonically increasing function of the underlier's price, one can quickly see that large underlier movements help the investor who is long a straddle. When the underlier's price goes up, the total delta of the straddle goes up as well, and the investor will need to sell the underlier to maintain a delta neutral portfolio. When the underlier goes down, the investor will need to buy the underlier. Hence, lots of movement in the underlier, or volatility, causes the investor to gain from his hedging transactions - he will always need to buy when the underlier is low and sell when high. In the same way, an investor with a short straddle will face the opposite situation - he will have to buy high and sell low when the underlier's price is moving. For investors with a view on the future volatility of a particular underlier, a straddle (or, for that matter, any option in general) can be a way to implement that view. Recently, the development of variance swaps allows investors to trade volatility directly without the need for constant delta hedging. For a further discussion of this style of investing, see volatility arbitrage.

Strangles

A strangle is an options strategy similar to a straddle, but with different strike prices on the call and put options. This is used to bias the profitability of the strategy towards one particular direction of price movement in the underlying, while still offering some (reduced) protection against a movement in the other direction.
For example, the trader in the example above might enter into a strangle if he believes that XYZ's financial statement will probably be positive, but he is not certain and still wants to hedge some of the risk of a negative statement (and is willing to pay for this privilege.)

Nick Leeson and the Barings Bank collapse

Nick Leeson took short straddle positions when chasing losses he had run up for his employer, Barings Bank. He had initially invested in futures on the Nikkei 225 stock index. Following a dramatic fall in the market, largely due to the Kobe earthquake, Leeson lost millions. He tried to re-coup these losses by investing in the higher risk, but potentially more rewarding, straddles. He bet that the Nikkei would stabilise and stay in a range around 19,000. His bet failed and losses escalated to $1.4bn, causing the bankruptcy of Barings.

References

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External links

straddle in German: Straddle (Wirtschaft)
straddle in French: Straddle
straddle in Hebrew: אסטרטגיית אוכף
straddle in Dutch: Straddle
straddle in Polish: Transakcja stelażowa

Synonyms, Antonyms and Related Words

abstain, abut on, across, amble, astraddle, astride, barge, be based on, bear on, bestraddle, bestride, bowl along, bundle, bypass, call, carry, clump, cop out, cover, cross, drag, duck the issue, encompass, environ, evade, evade the issue, extend, flounce, foot, footslog, ford, get ahead of, go, go across, go by, go out, halt, hippety-hop, hitch, hobble, hold, hop, horseback, jog, jolt, jump, lean on, lie, lie on, limp, lumber, lunge, lurch, mince, on, on horseback, option, overstride, pace, paddle, pass, pass by, pass over, peg, perch, piaffe, piaffer, plod, prance, put, put and call, rack, ramble, range, reach, reach out, rely on, repose on, rest on, ride, right, roll, run, sashay, saunter, scramble, scuff, scuffle, shoot ahead of, shuffle, sidle, single-foot, sit it out, sit on, skip, slink, slither, slog, slouch, span, sprangle, spread, spread-eagle, stagger, stalk, stamp, stand neuter, stand on, step over, stock option, stomp, straddle-legged, straddleback, straggle, strap, stretch, stretch out, stride, strip, stroll, strut, stump, surround, swagger, sweep, swing, take in, thrust out, tittup, toddle, totter, traipse, trim, trip, trudge, waddle, wamble, wiggle, wobble
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