Options Help For Series 7 Test - Long Straddles

Help and Understanding Long Straddles for the Series 7 Licensing Exam.

A straddle is using calls and puts at the same time. There are long and short straddles. A long straddle is the buying of calls and puts on the same stock or security. Short straddling is shorting calls and puts on the same security. Straddles are tested on the Series 7 exam or other exam where options are part of the outline.

Long Straddle Example

BUY 1 DFG DEC 70 CALL @ $600
BUY 1 DFG DEC 7O PUT @ $150

The main profit aim for DFG stock to rise or fall below the break even points. There are 2 break evens with long straddles since a call and put are held and were paid for. Most long straddle holders are anticipating big movement in the security. They are usually neither bullish or bearish (those terms are more used
with spreads).

BREAK EVEN

The Series 7 will ask the break-even points for straddles. For this straddle:

Call is the strike price plus the COMBINED PREMIUMS. The combined premiums are 750.

So the B/E for the call option side is 77 1/2

The Put side of the long straddle would be the 70 strike price minus the combined premiums of 750 or 7 1/2.

Thus the Break Even for the Put is 62 1/2

Maximum gain on Long Straddles is UNLIMITED.

This is because of the call side of the straddle. If the price of DFG rises above 77.50 and continues to rise, the put can be allowed to expire or traded away. Either way, there is no limit to how high the rise of the stock can go. Anytime you are long a call and do not have an "obligation" that the long call
is covering, your maximum gain is unlimited. If on the Series 7 exam, they present a scenario where the call is traded away and the put is still active, it is no longer a long straddle and the put maximum gain would be the break even in dollars. In this case, the maximum gain is $6250.

The maximum loss is the combined premiums paid. All long straddle's maximum loss is the premiums paid for the call and the put. Obviously if more than 1 contract was bought, the figure will be higher in dollars. If the above example said 3 contracts were bought. The maximum gain would still be unlimted. The break even points would be the same, but the maximum loss would be tripled. 750 times 3.

Series 7 Topic Tip

Key Things to remember on Long Straddles:

They must involve calls and puts
they must be both bought
the profit is heavy movement so the premiums are covered.
No movement will result in a loss of the contracts are held and allowed to expire.
Remember to count the contracts correctly
There will be 2 break even points


Short Straddles will be talked about in a future post, but feel free to post a question here and we'll be happy to answer it.

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