InvestorQ : How do I use straddles to play markets that are largely directionless in nature?
Sam Eswaran made post

How do I use straddles to play markets that are largely directionless in nature?

swati Bakhda answered.
3 years ago

In a straddle you buy the call option and a put option of the same strike price. Effectively, you are betting that the market index or the stock is going to give a breakout but you are not sure which direction this breakout will happen. Infosys is a classic example on its results day. In the past there were quarters when Infosys has outperformed on the results day and there are enough occasions when it has underperformed on the results day.

Let us say Infosys 1100 call option is quoting at Rs.25 and the Rs.1100 put option is quoting at Rs.50 while the current market price of Infosys is Rs.1090. You can create a straddle by buying one lot of 1100 call option and one lot of 1100 put option. The total cost of the straddle is Rs.75, which is the sum of the premiums of the call and the put. So you are profitable either if the stock price of Infosys goes above Rs.1175 or if it goes below Rs.1025. When either of these limits is breached your straddle becomes profitable. You are betting on the volatility rather than on the direction of Infosys price movement.

Alternatively if you are expecting Infosys to be range bound between 1050 and 1150, then you can sell this straddle. As long as the stock stays in the price range of Rs.1025 and 1175, you are going to be profitable on the short straddle. Remember, short straddles are open-risk strategies as outside this range your losses can be unlimited. Also short options entail initial margins and MTM margins.