Straddle

The long straddle's value at expiration is the intrinsic value of whichever leg finishes in the money; the other expires worthless. Because one leg always dies, the buyer must recover the combined premium of both before showing a profit. The upper breakeven is the strike plus the total premium paid; the lower breakeven is the strike minus that same premium. Maximum loss equals the full premium and occurs only if the underlying settles exactly at the strike. Profit is theoretically unlimited on the upside and limited only by the underlying falling to zero on the downside.

Plotted against the underlying price, the position forms a V with its vertex at the strike, shifted down by the premium. The short straddle is the mirror image: an inverted V capped at the premium received, with losses that widen without bound as the underlying travels away from the strike in either direction.

An at-the-money straddle begins with delta close to zero, since the call's positive delta roughly offsets the put's negative delta. That neutrality is temporary. Gamma is at its maximum near the strike, so any move immediately builds directional exposure in the profitable direction, which is why a long straddle is described as long gamma.

Vega is also positive and largest for at-the-money options, making the position a direct long exposure to implied volatility. The offsetting cost is theta: time decay is steepest for at-the-money options as expiry approaches, and the long straddle pays that decay on two contracts at once. The short straddle inverts every sign, collecting theta while carrying negative gamma and negative vega. In practice, the holder is trading realised volatility against the implied volatility embedded in the premium paid.

Because an at-the-money straddle is nearly direction-neutral, its price is read directly as the market's expected absolute move in the underlying through expiration. Dividing the straddle premium by the spot price gives a percentage move often quoted before earnings releases, central bank decisions, elections, drug trial results and merger rulings. Event-driven desks compare that implied move with their own estimate of the distribution of outcomes rather than with a target price.

Straddles also serve as a construction tool. Selling at-the-money straddles is the core of many premium-harvesting and volatility-carry programs, and delta-hedged straddles let market makers isolate the difference between implied and realised volatility. On the exam, straddles reappear in the context of a manager who expects turbulence without a view on direction, and as the natural comparison for a strangle, which uses out-of-the-money strikes for lower premium and wider breakevens.

Expect to compute, from a strike and two premiums, the total cost, both breakeven prices, the maximum loss and the profit or loss at a stated expiration price. Practise stating the payoff as a function rather than memorising cases: value equals the greater of zero and the strike minus the underlying, plus the greater of zero and the underlying minus the strike, less premium paid.

You should also be able to identify a straddle from a described view, distinguish it from a strangle and from a collar or spread, and explain why a short straddle carries unlimited theoretical loss and margin requirements that a long straddle does not. Finally, be ready to explain, qualitatively, why a correct forecast of a large move can still lose money once the premium and implied volatility level are considered.