How A Straddle Works?

A straddle is an options trading strategy where the investor holds a position in both a call and a put option with the same strike price and expiration date. The aim is to profit from volatility, regardless of the direction in which the underlying asset’s price moves. Here’s how it works:

1. Buy a Call Option: Gives you the right to buy the underlying asset at a specific strike price before the option expires.
2. Buy a Put Option: Gives you the right to sell the underlying asset at the same strike price before the option expires.

### Payoff Structure

• Profit if Volatile: If the asset price moves significantly, either up or down, one of the options will become profitable enough to cover the loss from the other option and still provide a net gain.
• Loss if Stable: If the asset price remains stable, both options will expire worthless, leading to a loss equal to the total premium paid for both options.

### Mathematical Formulas

The profit from a straddle can be calculated as:

max(S — K, 0) + max(K — S, 0) — C — P

Where:

• S= Final stock price
• K= Strike price
• C = Cost of the call option
• P= Cost of the put option

### Scenarios

1. Bullish Market: If the asset price rises, the call option will gain value.
2. Bearish Market: If the asset price falls, the put option will gain value.
3. Stable Market: Both options will lose value, and you lose the sum of the premiums.

REFERENCES

ChatGPT 4 and Dall•E 3