Buying Index Straddles

 

Index XYZ is between 103.20 or below 96.80 at expiration
 

Buy 1 XYZ 100 Call at $1.70
Buy 1 XYZ 100 Put at $1.50

 
With index XYZ exactly at the strike price of 100 at expiration, both the 100 call and the 100 put would expire exactly at-the-money and with no value. The maximum, predetermined loss of $3.20 (or $320 total) would be realized.

At expiration, with XYZ at either the upside break-even point of 103.20, or the downside break-even point of 96.80, the call or puts intrinsic value would be $3.20, the initial cost of the whole straddle.

With XYZ closing at expiration between 103.20 and 96.80, but not at the 100 strike price, one of the options would expire in-the-money and have intrinsic value, with the other expiring worthless. In this case the in-the-money option could be either sold or exercised to recoup some of the original straddle purchase price resulting in a partial loss for the position.

For example, index XYZ closes at 102 at expiration. The put would expire out-of-the-money and with no value, and the call would have an intrinsic value (or cash settlement amount) of:

   102   XYZ index level
-$100   call strike price
    $2   intrinsic value (cash settlement amount)

The level of index XYZ did change over one month, but not as much as anticipated. The straddle that cost $3.20 is now worth only the intrinsic value of its in-the-money call, or $2. The investor could sell the call and recoup some of the straddle’s initial purchase price. If the XYZ 100 call is sold for its intrinsic value of $2 then the loss for the position would be:

  $3.20  premium initially paid for straddle
 -$2.00  premium received at call’s sale
  $1.20   partial loss

With XYZ at 102 at expiration, the in-the-money XYZ 100 call could also be exercised. The exercise settlement value would be the closing index level of 102. The cash settlement amount would be: 102 (settlement value) – $100 (call strike price) = $2. The partial loss would be the same as if the call were sold for intrinsic value at expiration:

  $3.20  premium initially paid for straddle
 -$2.00  premium received at call’s exercise
  $1.20  partial loss

 
 

Previous Next