from the strike price in either direction, the higher the net value of the
options.
Above $70, the call has value. If the underlying is at $74.25 at expiration,
the put will expire worthless, but the call will be worth 4.25—the price
initially paid for the straddle. Above this break-even price, the trade is a
winner, and the higher, the better. Below $70, the put has value. If the
underlying is at $65.75 at expiration, the call expires, and the put is worth
4.25. Below this breakeven, the straddle is a winner, and the lower, the
better.
Why It Works
In this basic example, if the underlying is beyond either of the break-even
points at expiration, the trade is a winner. The key to understanding this is
the fact that at expiration, the loss on one option is limited—it can only fall
to zero—but the profit potential on the other can be unlimited.
In practice, most active traders will not hold a straddle until expiration.
Even if the trade is not held to term, however, movement is still beneficial
—in fact, it is more beneficial, because time decay will not have depleted
all the extrinsic value of the options. Movement benefits the long straddle
because of positive gamma. But movement is a race against the clock—a
race against theta. Theta is the cost of trading the long straddle. Only pay it
for as long as necessary. When the stock’s volatility appears poised to ebb,
exit the trade.
Exhibit 15.2 shows the P&(L) of the straddle both at expiration and at the
time the trade was made.