Straddles and Strangles for Volatility Bets

Straddles and strangles are volatility strategies that profit from large price movements in either direction. Unlike directional trades, these positions don't require predicting whether the underlying will rise or fall—only that it will move significantly. They're commonly used around earnings announcements and other binary events.

Definition and Key Concepts

Long Straddle

A long straddle combines:

• Buy 1 ATM call
• Buy 1 ATM put
• Same strike price and expiration

Both options have approximately 0.50 delta (opposite signs), creating a near-neutral starting position that profits from movement in either direction.

Long Strangle

A long strangle combines:

• Buy 1 OTM call
• Buy 1 OTM put
• Same expiration, different strikes

Strangles cost less than straddles but require larger moves to profit.

Short Versions

Selling straddles and strangles reverses the risk profile:

• Short straddle: Collect premium, profit if stock stays near strike
• Short strangle: Collect premium, profit if stock stays between strikes

Short versions carry significant risk if the underlying makes a large move.

Strategy Comparison

How It Works in Practice

Long Straddle Construction

Example: XYZ trades at $50. Earnings are tomorrow.

Trade:

• Buy 1 XYZ $50 call at $3.00
• Buy 1 XYZ $50 put at $2.75
• Total cost: $5.75 ($575 per contract)

Greeks Profile:

Breakeven Analysis:

The stock must move more than 11.5% (to $55.75 or $44.25) to profit.

Long Strangle Construction

Example: Same situation, but you want lower cost.

Trade:

• Buy 1 XYZ $55 call at $1.25
• Buy 1 XYZ $45 put at $1.00
• Total cost: $2.25 ($225 per contract)

Breakeven Analysis:

The stock must move to $57.25 (14.5% up) or $42.75 (14.5% down) to profit.

Worked Example

Earnings Straddle Trade

ABC reports earnings after close. The stock trades at $100. You expect a large move but don't know the direction.

Current Market:

• ABC at $100
• Pre-earnings IV: 65%
• Historical post-earnings move: average of 8%

Trade:

• Buy 1 ABC $100 call at $6.50
• Buy 1 ABC $100 put at $6.00
• Total cost: $12.50 ($1,250 per contract)
• Days to expiration: 3

Position Metrics:

Scenario Analysis:

Key Insight: The stock's average historical move of 8% is less than the 12.5% breakeven. This straddle is priced for a larger-than-average move. Unless ABC beats or misses expectations significantly, the trade loses money.

Implied Move Calculation: Straddle price / stock price = $12.50 / $100 = 12.5%

The market is implying a 12.5% move. You should only buy if you expect a larger move than that.

Risks, Limitations, and Tradeoffs

Time Decay

Straddles and strangles are heavily affected by theta decay. With two long options, daily decay is substantial. In the example above, -$0.45 daily theta means losing $45 per day just from time passing.

Volatility Crush

After earnings or events, implied volatility typically drops sharply. This "volatility crush" can cause losses even if the stock moves in your predicted direction. The vega loss may exceed the delta gain.

Example: Stock moves up 5% but IV drops from 65% to 35%.

• Delta gain from 5% move: ~$2.50
• Vega loss from 30% IV drop: 0.18 × 30 = ~$5.40
• Net loss despite correct direction

High Cost of Straddles

ATM options are expensive. Straddles require paying for two expensive options, making breakevens challenging to reach. Many straddle buyers pay too much relative to expected moves.

Common Pitfalls

1. Ignoring implied move: Always calculate what move is priced in before buying.

2. Holding too long: Time decay accelerates; if the move doesn't happen quickly, losses mount.

3. Underestimating IV crush: Post-event volatility drops can exceed 50%, devastating long vega positions.

4. Using straddles for small expected moves: These strategies need large moves; small moves lose money.

5. Overleveraging: Straddles can lose 100% quickly; position size accordingly.

Checklist for Volatility Strategies

• Calculate the implied move priced into the straddle/strangle
• Compare implied move to historical average move for similar events
• Assess current IV versus historical IV (elevated or depressed?)
• Determine breakeven prices on both sides
• Account for theta decay over expected holding period
• Estimate potential IV crush and its impact on position value
• Set exit rules: take profit if move occurs, cut losses if it doesn't
• Consider timing: enter shortly before event to minimize decay

Next Steps

For strategies that use delta to manage directional exposure precisely, see Using Delta as a Hedge Ratio. Understanding delta helps in adjusting straddles and strangles as the underlying moves.

For range-bound alternatives that profit from the opposite scenario, review Iron Condors, Butterflies, and Variations.