STRADDLES

A straddle strategy involves a put and a call option with the same exercise price and same exercise date and on the same underlying security. There are two types of straddles, a long straddle and a short straddle.

A long straddle involves buying one call and one put on an underlying security with the same exercise price and the same exercise date.

Here is an example of a Long Straddle strategy. Question:TATA Motors share is selling for INR 245 on 8th September, 2012 and has a call as well as put option on it with an exercise price of INR 250 and expiration date of 27th September, 2012. The price of call is INR 6 and price of put is INR 8. What would be the gain or loss if investor enters into a long straddle using options with the exercise date of September 27 and an exercise price of INR 250?

Answer: Table 2: Profit from the long straddle position Stock Price (INR) Gain from call (INR) 180 200 220 240 250 260 280 300 320 -6 -6 -6 -6 -6 4 24 44 64 Gain from Put (INR) 62 42 22 2 -8 -8 -8 -8 -8 Gain from the Straddle (INR) 56 36 16 -4 -14 -4 16 36 56

Break- Even Point: Long call = INR 250 + INR 6 = INR 256 Long put = INR 250 - INR 8 = INR 242

70 60 50 40 30 Gain/Loss 20 10 0

Chart Title

Gain from call (INR) Gain from Put (INR) Gain from the Straddle (INR)

180
-10 -20

200

220

240

250

260

280

300

320

Stock Price

The investor with the long straddle will make a loss as long as the TATA Motors share price is within the range of INR 236 to INR 264. If the price is below INR 236 or above INR 264, this strategy will result in a profit. The more the price moves away from INR 236 or INR 264, the higher are the gains.

A long straddle strategy is appropriate if an investor expects a large movement in the stock price but is not sure about the direction of the stock price or whether to invest in a bullish or bearish market.

STRANGLES
A strangle involves the purchase of a put and a call with the same expiration date but with the different exercise prices. The call exercise price is generally higher than the put exercise price.

Here is an example of a Long Strangle strategy. Question:HUL stock is trading at INR 540 on 8th September, 2012. There is a call on HUL share with an exercise price of INR 560, selling for INR 4 and a put option with an exercise price of INR 520, selling for INR 3. What would be the gain or loss if investor enters into a strangle using options with exercise date of September 27 with exercise price of INR 560 and INR 520.

Answer: Table 3: Profit from the Strangle Position Stock Price (INR) Gain from the Long Call (INR) S.P. = 560 400 440 480 520 560 600 640 680 -4 -4 -4 -4 -4 36 76 116 Gain from the Long Put (INR) S.P. = 520 117 77 37 -3 -3 -3 -3 -3 113 73 33 -7 -7 33 73 113 Gain from the Strangle (INR)

The table show that the strangle strategy will result in a maximum loss of INR 7 as long as the stock price is in the range of the two exercise prices. The investor will make a profit only if the stock price is below INR 513 or above INR 567.

Gain from a Strangle

140 120 100 80 Gain / Loss 60 40 20 0 400 -20 440 480 520 560 600 640 680

Gain from the Long Call (INR) Gain from the Long Put (INR) Gain from the Strangle (INR)

Stock price

Break- Even Point: Long call = INR 560 + INR 4 = INR 564 Long put = INR 520 - INR 3 = INR 517

 A Strangle is similar to a straddle in the sense that the investor is not sure about the direction of the stock price or whether to invest in a bullish or bearish market.