Crypto Options Trading Strategy: Introduction to the Long Straddle

okx learn
OKX Learn
2020.06.20

Like in traditional finance, options are derivatives contracts based on another asset. What makes them different from other investment vehicles is how people trade them. An investor or trader gets the right to buy/sell assets at a pre-determined price and date. This allows them to take advantage of the price behavior of the underlying asset, assuming that they can predict it.

As such, options trading comes with fairly low risk, while at the same time, it is a low-cost approach to trading. There are two types of crypto options — call and put. Call option represent the right to buy, while put options are the right to sell. However, for the best result, users have to employ options trading strategies, such as the straddle strategy. 

Best Option Trading Strategies

Option trading strategies are actions where the trader buys calls, puts, or both simultaneously in a specific way. The way in which the trader buys them is specially designed to limit losses and secure high profits. Simply put, strategies represent special combinations of trading activities that can result in the best outcome for the trader.

There is a great variety of available strategies out there for traders to utilize. Here are several examples that you can consider:

Naked Puts

Puts represent the sale of options, such as securities. If you sell such options without possessing the underlying asset (in this case, securities), that is called a “naked put.” This is a popular strategy that is bullish in nature. Its main benefit is the fact that it lets you bet that the price will go up. 

If this happens, the put option expires, and you keep the premium. If it doesn’t happen, you will likely have to buy the securities and pay the strike price for them. This is usually what happens if the price goes down instead of up, as you predicted. But, even if it happens, you can still benefit from the premium that you paid.

Covered Calls

Another popular strategy involves selling call option. In this case, you, presumably, already own the underlying asset. The call option that you sell will have a strike price, and you can even specify the expiration date.

This strategy allows you to profit because you are selling the options at a greater price than the strike price. Even if the price of the asset increases, the buyer can still buy the asset at the strike price. As a result, you get to profit from the option premium.

Iron Condor

Iron Condor might be an intimidating name, but it is also a very popular strategy. It revolves around selling call and put options with different strike prices. As such, it is a somewhat neutral approach, as you bet that the price will stay within a certain range. If your prediction is correct, both of your options will expire, making them worthless. On the plus side, you can keep the premiums and consider them a profit.

Long Straddle Options Strategy

Another example of a strategy where you buy both a call and a put is called long straddle straddle. However, the long straddle strategy differs from the previous one because this time, you put the same strike price. The expiration dates are also identical for both, and the goal is to profit from a strong price move. 

Such moves are usually triggered by major events, and the price can move either way, depending on the event. They come with a bit of a risk of loss, as you require a very strong price reaction. Mild price movement will usually spoil the strategy.

Short Straddle Options Strategy

A 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 is typically for more advanced traders.

What Are Straddles, and How Are They Chosen?

Straddle options strategies are neutral options strategies for buying and selling both put and call options at the same time. They involve 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.

Choosing straddles is the more complex part. Traders use straddle when they expect incoming volatility. They select it based on predictions of the trading range of the underlying asset by the selected expiration date. In other words, you need to do research involving the asset and predict what will happen. 

Given its close ties to volatility, a straddle is the most effective for highly volatile trading instruments. Assets that rarely see significant price moves usually can’t help you make a profit. Assets such as cryptocurrencies are, therefore, among the best choices. 

How Does a Straddle Work?

The way this works is simple. For example, if you expect a large price move, you pay a certain premium and select a long straddle. If the asset's price rises from the strike price by an amount greater than the premium you paid, you profit. 

You will also profit if the price falls by an equally large amount. In other words, the only real risk lies in the strength of the market’s reaction. If the price move wass weak, then a long straddle was a bad strategy.

In that scenario, where the market moves with smaller volatility, a short straddle strategy comes in handy. Of course, there is also risk involved, as the market might move more than expected. In this case, you could also see losses.

Pros and Cons of the Long Straddle Strategy

Long straddle pros:

  • Long straddle breakeven points are relatively close together
  • You can profit whether the price rises or falls
  • The chance of losing 100% of the straddle’s cost if the position expires is lower
  • Long straddles are generally less sensitive to time decay
  • You get fixed risk with potentially unlimited gains
  • You can take advantage of major, newsworthy events

Long straddle cons

  • You can purchase fewer long straddles if you are on a budget, as you must pay two premiums
  • You need significant volatility for the long straddle to pay off

IV and Time Decay: Two Factors To Watch

IV (Implied Volatility) and Time Decay are two factors that can significantly affect your straddle strategy. 

Let’s start with implied volatility. IV is one of the most important concepts to understand if you are new to options trading. Especially if you are new to options strategies like a straddle. It indicates how volatile the market can become in the future. As such, it is used for setting up an expiration date for your options contracts. Apart from that, it is also very useful in probability calculation. IV is crucial in accurately assessing how the underlying asset might move by a certain date.

On the other hand, there is time decay. This 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 is an exception to the rule, which happens when the option is ITM (In-The-Money). If the option is ITM, it can retain some of the value even as the contract approaches its expiration date.

In other words, the contract loses value the closer it gets to expiring, which is something that traders must remember.

Is Long Straddle a Good Strategy To Use?

The long straddle strategy is a valid strategy used by options traders worldwide. As with all other strategies, it has its advantages and disadvantages. It is by no means perfect or risk-free. However, that doesn’t mean that it isn’t profitable under the right circumstances. 

Calculating the circumstances accurately is every trader’s main concern with a long straddle. Essentially, traders should only use it when they are certain the market will see strong volatility soon. Fortunately for crypto options traders, such volatile price moves are fairly common. In the end, you use all option trading strategies at your own risk. 

FAQs

Is Straddle a Good Strategy?

Straddle can be a good strategy under certain conditions. Primarily, it requires specific market movements, depending on whether you wish to use long or short straddle. In both cases, volatility is the key; only long straddle needs strong volatility, while short needs small moves.

Is Straddle Always Profitable?

Straddle is profitable if you pick the right one for the market conditions that are about to come. Selecting short straddle during periods of great volatility of the underlying asset will lead to losses. Meanwhile, selecting a long straddle when the market is calm will also lead to losses. 

Is the Straddle Strategy Risky?

Straddle can be risky, but there are positive sides to it. For example, you don’t need to worry about the direction of price movement. All you need is the strength of the move, so if major events happen, the risk can drop exponentially.

What Is a Long Straddle?

A long straddle is a straddle strategy that traders use to profit from an underlying asset’s strong price moves. It requires paying premiums for both option positions, a call and a put. As such, a long straddle is perfect for highly volatile assets but not so much for low-volatility assets.

Can You Lose Money on a Straddle?

Yes, losing money on a straddle is possible if your prediction is incorrect. Poor predictions of market behavior will likely have you select the wrong straddle. In that case, you are exposing yourself to a risk of loss.