A long straddle involves going long (i.e. buying) a callandput option on some stock, interest rate, index or other underlying. The two options are typically bought at the same strike and expiry at the same time. The owner of a long straddle makes a profit if the underlying price is a long way from (either above or below) the strike price. Thus an investor may take a long straddle position if he thinks the market is highly volatile but does not know in which direction it is going to move.
Conversely a short straddle is the exact opposite position, i.e. going short (selling) the two options. The investor makes a profit if the underlying price is close to the strike at expiry. Thus the investor thinks the markets are unlikely to move much between purchase and expiry of the options. A short straddle position is highly risky.
Nick Leeson took short straddle positions when chasing losses he had run up for his employer, Barings Bank. He had initially invested in futures on the Nikkei 225 stock index. Following a dramatic fall in the market, largely due to the Kobe earthquake, Leeson lost millions. He tried to re-coup these losses by investing in the higher risk, but potentially more rewarding, straddles. He bet that the Nikkei would stabilise and stay in a range around 19,000. His bet failed and losses escalated to $1.4bn, causing the bankruptcy of Barings.
In finance, a straddle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on the magnitude of price movement in the underlying security, regardless of the direction of price movement.
Thus, an investor may take a long straddle position if he thinks the market is highly volatile, but does not know in which direction it is going to move.
A shortstraddle position is highly risky, because the potential loss is unlimited, whereas profitibility is limited to the premium gained by the initial sale of the options.
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