3 Tips for Buying a Straddle to Make a Profit

Options trading is one of the more confusing investment strategies out there. Despite its learning curve, it can offer some serious rewards if you take the time to learn about it. Consider these tips for buying straddles to start making a profit from your options trades and increase your profits.

What Is Options Trading?

Options trading is a unique style of investing. Rather than purchasing an actual share of a company’s stock, you purchase a contract with the option (but not the obligation) to sell the asset associated with the contract before the contract’s expiration date. Options trading is a great way of making a profit by deploying complex stock market strategies.

Broadly speaking, there are two types of options contracts — call options and put options. An investor purchases a call option when they expect the price of the underlying asset to rise within the confines of the contract, while an investor purchases a put option when they expect the price of the underlying asset to fall within the confines of the contract.

What Is a Straddle?

Investors can use a multitude of options strategies to make an income, but the straddle is one of the most potentially profitable. The investor purchases both a put option and a call option for the same asset with the same expiration date at the same time and for the same strike price. This way, the investor stands to make a profit whether the underlying asset increases or decreases in value, as long as the change in price is greater than the overall cost of both options contracts.

3 Tips for Buying Straddles

Purchasing straddles comes down to timing. Use these tips to help you establish when you should buy and sell your options for maximum profit:

Purchase the Long Straddle

A long straddle is a straddle purchase the investor buys prior to an earnings release with the expectation that the underlying asset will lose or gain a sizable amount of money. Long straddles stand to make investors a lot of money very quickly, but they do take some research to ensure a large enough swing in valuation to make a profit.

Buy Early

Do your research, decide which stocks you want to straddle, and then purchase your options early. The earlier you can buy before the release of an earnings report, the cheaper you can get your options and the more you stand to make if the underlying asset rises or drops dramatically.

Use the Volatility

Super volatile stocks, particularly those of big-name companies with highly anticipated earnings reports, are great choices for straddle purchases. Since these stocks tend to follow a consistent pattern of up and down swings based on the release of earnings reports, you can purchase straddles that benefit you during those swings.

Options trading, while complex, offers an enormous opportunity for profit. Use the straddle strategy and these related tips to help you make the most money off of your options trades.

Image via Flickr by Nancy Devine