Last week we talked about using options, puts and calls, to make a profit in an uncertain market. Another option in the options market is to use both a put and a call at the same time. Using a straddle may be the best bet if you believe that a stock will move significantly and you really have no idea which direction.

What is a Straddle?

A straddle is one of those wonderful words that sound like what they mean. A straddle lets you benefit whether the stock moves up or down. It the stock does not change price you have paid for both a put and a call.

We are talking about a “long” straddle in this case. You purchase the right to buy (a call) and right to sell (a put) at the same strike price and same time. This strategy is meant for a volatile market or, in the case of the current budding economic recovery, the possibility of great economic news versus the chance of profit taking or bad news. With earnings reports coming up stocks may break up or down, not as a pack, but individually based upon results versus earnings predictions.

Everyone seems to think that things will get better and no one knows for sure when. The P&G’s of the world are weathering the storm but we have already talked about them. A lot of strong, well-positioned companies have seen their stocks rise based upon expectations. The street being the strange creature that it is good earning reports can be punished if the earnings do not meet expectations.

Not to worry. Do a long options straddle on promising stocks where there is uncertainty as to earnings. Do a long options straddle on promising stocks where profit taking may or may not interrupt an upward climb.

If you are truly betting on a stock going up all you need to do is buy a call option and if you truly believe that the stock will go down all you need to do is buy a put option. The straddle option, long straddle option, is for the uncertainty of market or individual stock volatility.

Another place to consider a long straddle option is with biomedical companies with a hot new drug in the pipeline. Historically these stocks are bid up in advance of the release of research reports. If the research is good the stock continues up and if the report is bad the stock collapses. A long straddle option covers the uncertainty of both possibilities.

This article is about long straddles. The other strategy, a short straddle, should come with big letters attached. KIDS, DON”T TRY THIS AT HOME! A short straddle is a bet on a stock not moving. If you bet wrong on this you lose your shirt as well as your home, your car, you bank account, etc. If this one goes wrong you end up selling low and buying high (stock went up) or buying high and selling low (stock went down). The only recompense would be that you get paid for both the put and the call. For the unwary this strategy should also involve updating your passport and booking a flight to Rio de Janeiro!

This disclaimer aside, consider long straddles, so long as the market remains edgy during the early phases of the recovery market.

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