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Friday, November 25, 2016

What is a Straddle?


Traders uncertain of market direction can usually opt for a variety of options combinations one of them being a straddle ­ which literally means to be on both sides of something.

1. What is a straddle?

A strategy using Nifty options usually before a major event or when one is uncertain of market direction. It comprises purchase of a Nifty call and put option of the same strike price. Usually strikes are pur chased closer to the level of the underlying index.

2. What is better ­ buying or selling a straddle?

Depends. Implied volatility of options, or near-term expectations of price swings in an un derlier like Nifty, usually peaks before an event and falls when the outcome plays out ­ like Infy results in past years. However, once the event plays out a sharp rise or fall in Nifty could result in price of the straddle rising ­ benefiting buyers. But, normally , those who sell or write options charge hefty premiums from buyers in the hope that fall in volatility would en sure the options end out-of the-money , hurting buyers.

3. So, do straddle sellers end up winning most of the time?

Yes. That's invariably the case when market volatility is trending on the lower side. For instance, when the market closed at 7861, a 7900 strike call and put expiring in December cost a combined Rs 87. But when the market rose by 44 points, one session later breaching the 7900 mark, the value of the straddle shrank to Rs 71. The buyer was left staring at a mark-to-market (MTM) loss of Rs 16 a share (or Rs 1200 a lot) while the seller was sitting on an MTM gain of Rs 16.

4. When do buyer's gain?

When the market moves in either direc tion and breaches the combined cost of the straddle. That is if it falls the value of the put purchased should be more than the combined cost of the call and put together. Or if it rises the call value should cross that of the combined price of the straddle. In reality , that is rare, except ahead of an event like Infy results or a financial crisis like the one in 2009.

5. Currently who are selling straddles?

Mainly brokers who run proprietary trades and some rich clients. FPIs are net buyers of puts and sellers of index calls on an outstanding basis. Buyers of calls are DIIs who can purchase but can't write options.



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