For our straddle, let's say, we were observing Amati Communications, symbol AMTX, for some time and we noticed that the stock has been going up and down sharply. We also know that earnings results for the last quarter are due in ten days. At this point nobody can predict the outcome of the report. If the results are better than anticipated the stock value will move up, but if the results are below the Market anticipation the stock value will decline. Assuming you already know the Straddle technique, you can take advantage of this uncertainty.

We decide to buy shares of Amati Communication at a current stock price of $14.00 a share. We buy a Straddle using the exercise price of $15.00. IT IS JANUARY. WE DECIDE TO BUY THE CALL FOR $0.70 AND THE PUT FOR $1.20 FOR THE FEBRUARY EXPIRATION DATE.

EXPIRATION DATES: are always the third Friday of each month!

STRIKE PRICE: Is the price at which the underlying stock will be sold if the buyer of the option exercises the purchase.

PREMIUM: Is how much you pay when you buy an option or how much you receive if you sell it.

CONTRACTS: options are always written in 100 shares.

One contract = 100 shares

Our Straddle on AMTX for 300 shares is equal to buying 3 call contracts and to buying 3 put contracts for the $15.00 strike price for February expiration.

YOU HAVE TO SPEND

300 shares x $0.70 = $210.00, for the 3 call contracts

300 shares x $1.20 = $360.00 for the 3 put contracts

Total paid for Straddle = $570.00

REMEMBER: THE STRATEGY IS NOT TO EXERCISE YOUR STRADDLE BUT TO SELL IT BEFORE THE EXPIRATION DATE, AS SOON AS IT HAS REACHED A GAIN THAT YOU ARE SATISFIED WITH. AS A RULE OF THUMB, PROFIT WILL BE MORE SUBSTANTIAL BY SELLING THE STRADDLE YOUR BOUGHT THAN EXERCISING IT. YOUR BROKER WILL HANDLE THE TRANSACTION AFTER NOTIFICATION. HOWEVER, FOR SIMPLIFICATION, WE WILL USE AN EXAMPLE WHERE THE STRADDLE IS EXERCISED.

Return Example 1

 If from the time we bought the Straddle until its expiration date the STOCK PRICE OF AMTX WENT UP FROM $14.00 TO $17.50 we can exercise the call option or sell it while the put* option expires worthless.

The cash flow of this transaction is as follows:

You paid $1.90 per share for this Straddle (call and put). As the strike price is $15.00 and the stock price is at $17.50 we have $2.50 difference - $1.90 invested =$0.60 per share. A 31.58% profit. For purposes of simplification commissions are not included.

*Remember that an option is always worth something before expiration, so you could always sell your put if you think the stock is not about to turn around for a decline in value. Make sure the commission does not take away what ever you will receive by selling this put.

Return Example 2

If from the time we bought the Straddle until its expiration date the STOCK PRICE OF AMTX WENT DOWN FROM $14.00 TO $12.50, we can exercise the put option or sell it while the call* option expires worthless.

The cash flow of this transaction is as follows:

You paid $1.90 per share for this Straddle (call and put). As the strike price is $15.00 and the stock price is at $12.50 we have $2.50 difference - $1.90 invested =$0.60 per share. A 31.58% profit. For purposes of simplification commissions are not included.

*Remember that option always worth something before expiration, so you could always sell your call if you think the stock is not about to turn around and go up in value. Make sure the commission does not take away what ever you will receive by selling this call.

As we see, by buying a straddle, you benefit if the stock moves one way or another by more that what you paid for it. In our case, the stock price has to move higher than $16.90 or lower than $13.10.

Now what happens if stock stays between $16.90 and $13.10? Unfortunately, we are losing some money. The closer the stock value to the strike/exercise price the more we lose.

One thing to remember is that an option has time decay: it means that if everything else remains the same (for example the stock price of Amati remains $14.00) the closer we get to expiration day the lower the price of the option becomes.

If at some point you feel that the stock is not going anywhere you can always close (sell) your Straddle position to recover part of your investment.

All In The Money allows you to choose and daily monitor your Straddles position and decide for the best.