The straddle is one trading strategy preferred by many binary traders. It uses a call and a put option in which you can set the same strike price and a simultaneous expiry time. You can take advantage of this tool when you are not sure how the price of an underlying asset is going to affect but you know that the variation will be substantial.
To make the most of the straddle strategy you have to comply with certain conditions, such as:
- Price oscillations must be short term.
- Price oscillations must be substantial.
- An increase of implied volatility in the market is necessary.
- If the price oscillations are insignificant, you may not be able to make enough profits to cover the cost of the trade.
Take advantage of the Straddle Strategy
To show you how you can from the straddle strategy, let us illustrate you on this matter. Suppose you purchased a GBP/USD $2.20 straddle to expire in one month for 3 cents each way. This means that you paid 5 cents of premium in total for the straddle. Imagine that the exchange rate of the GBP/USD increases to $2.30, your earnings will subsequently increase to 10 cents ($2.30 -$2.20 = $0.10). With this rise in the exchange rate, your gross profit of 10 cents will perfectly cover the premium you paid at the beginning and will leave you with a profit of 5 cents (10 cents – 5 cents = 5 cents).
Risk Mitigation with the Straddle Strategy
You can use the straddle strategy in a different way with the “Delta Hedging”. This method will allow you to reduce the risk linked with unpredictable price oscillations by equalizing the short and long market positions. This means traders will not lose any of their capital because the call and put option will revoke access to the risk exposure. The only thing traders risk lose is the premium paid for the hedge.
Again, let us illustrate you on this matter. Think of the previous example; now imagine that the GBP/USD increases from $2.20 to $2.25 and decreases back to $2.20. When the GBP/USD gets to $2.25, you can set the delta hedge at the $2.25 level if you think the increment will carry on. Conversely, you have to be aware that as the market continues to increase, your market position will be long for the call option and short for the put option. If you want to avoid this case scenario, you have to both make your position shorter and eliminate your delta hedge.
If the stars are on your side and you experience a scenario similar to these examples, you will ended up making profits either way: when the price increases from $2.20 to $2.25 and when the price goes down from $2.25 to $2.20. You will then have a gross profit of 20 cents on your hedge that will allow you to cover without any problems the premium cost of 10 cents.
Implied Volatility in the Market
On the other hand, you can also find yourself in a situation where there is an increase in the implied volatility in the market; this will result in an increment on the total value of your options. This happens because the level of implied of volatility defines the market value of an option.
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