Module 8 · Lesson 7 of 13 · Options · About 5 minutes

Straddles and Strangles: Payoffs Built From Volatility

On this page
  1. What you will learn
  2. What is a straddle?
  3. What is a strangle?
  4. Why “long” and “short” volatility?
  5. Straddle and strangle diagram
  6. What this does not tell you about straddles and strangles
  7. Method in Practice
  8. Check yourself
  9. Reflect on your own process
  10. Sources

Before you read: Option Payoff Diagrams: Long and Short Calls and Puts

What you will learn

What is a straddle?

What happens if you hold both a call and a put at the same strike?

A long straddle is a call and a put on the same underlying, at the same strike and expiration. In a fictional example, the underlying is at $100, the 100 call costs $3 and the 100 put costs $3. The total premium is $6 per share. At expiration, the position is worth the distance of the price from $100. Break-even points are $94 and $106. Between them, the position loses money, with the largest loss, the full $6, if price ends exactly at $100.

What is a strangle?

What if the call and put had different strikes, both out of the money?

A long strangle uses an out-of-the-money call and an out-of-the-money put, for example a fictional 105 call for $1.20 and a 95 put for $1.30. The total premium is $2.50. Break-even points at expiration are $92.50 and $107.50. It costs less than the straddle but needs a larger move to reach either break-even.

Why “long” and “short” volatility?

Does any expiry inside the break-evens give a short seller the full premium as profit?

For the fictional calculations below, assume one unadjusted 100-share stock call and one put on the same stock and expiry, held as an intact matched pair; stock prices are nonnegative. Values are ideal expiry intrinsic-value comparisons, not a guarantee about exercise, resulting inventory or actual fills. Fees, interest, dividends and taxes are excluded except for the separately stated $4 cost illustration.

No. For this expiry-payoff comparison, net profit before costs = premium received − intrinsic value owed. The premium is received when the short position opens; receiving it is not the same as earning all of it. The intrinsic-value liability can consume some, all or more than that premium.

Buying a straddle or strangle pays for exposure to movement in either direction. Selling the pair reverses that expiry payoff, receiving premium while accepting large losses if the move is sufficiently large. Before expiry, implied volatility, time, price, bid/ask spreads and the separate legs’ sensitivities affect value; “long volatility” and “short volatility” are descriptions, not a guarantee that a single factor determines profit.

Fictional short straddle: Sell one 100-strike call for $3 per share and one 100-strike put for $3 per share, same expiry. Combined premium = $6 per share = $600 per pair. At expiry stock price S, intrinsic liability per share is |S−100|. Profit per share is 6−|S−100|.

Expiry stock price Intrinsic liability per share Profit per share Profit per 100-share pair
$94 $6 $0 $0
$100 $0 $6 maximum $600 maximum
$104 $4 $2 $200
$106 $6 $0 $0
$110 $10 −$4 −$400

Break-evens are $94 and $106, but the full $600 is the ideal pre-cost maximum only at $100, not everywhere between them. At $104, $600 premium minus $400 intrinsic liability leaves $200. If an explicitly fictional $4 total cost for the entire two-leg round trip applies, that $200 becomes $196 and the $600 maximum becomes $596. The listed break-evens and tables exclude costs; costs also shift actual break-evens.

Fictional short strangle: Sell a 95-strike put for $1.30 and a 105-strike call for $1.20, same expiry. Total premium = $2.50 per share = $250 per pair. Intrinsic liability per share is max(95−S,0)+max(S−105,0). Profit per share is 2.50 minus that liability.

Expiry stock price Intrinsic liability per share Profit per share Profit per 100-share pair
$92.50 $2.50 $0 $0
$95 $0 $2.50 maximum $250 maximum
$100 $0 $2.50 maximum $250 maximum
$105 $0 $2.50 maximum $250 maximum
$106 $1 $1.50 $150
$107.50 $2.50 $0 $0
$110 $5 −$2.50 −$250

Break-evens are 95−2.50 = $92.50 and 105+2.50 = $107.50. Maximum pre-cost profit occurs from $95 through $105 inclusive; the wider positive-profit interval is between the outer break-evens, excluding the zero-profit endpoints. Those are different regions. The matching long pair at the same premiums has the opposite pre-cost expiry profit at each listed price.

For these uncovered stock-option short pairs, upward loss is unbounded because of the short call; downside loss is substantial. Premium collected is not a loss limit. These ideal expiry calculations do not remove early-assignment, funding, execution or post-exercise underlying-position risk.

Straddle and strangle diagram

Four fictional expiry profit curves in dollars per share, before costs, for stock prices 80 to 120, with gridlines at +12 and −12. Top row, call K=100 and put K=100, premium 6/share = $600/pair: the long straddle is a V with its low at 100 and break-evens at 94 and 106; the short straddle is the inverted V, shaded where positive between 94 and 106, with its peak marked at 100 and a second mark at 104. Bottom row, put K=95 and call K=105, premium 2.50/share = $250/pair: the long strangle has a flat bottom from 95 to 105 and break-evens at 92.5 and 107.5; the short strangle has a flat plateau from 95 to 105 drawn thick, shaded where positive between 92.5 and 107.5, with a mark at 106.
Read the diagram step by step
  1. Fictional matched stock options: one call plus one put; same stock and expiry; 100-share multiplier; S ≥ 0.
  2. Every y-axis is net profit before costs, dollars/share. Multiply by 100 for dollars per matched pair. These are not option market prices.
  3. Stock at expiry ($/share); BE at outer ticks
  4. Minimum: −$6/share at S=100. Break-evens: 94 and 106.
  5. Max: $600 only at S=100. At S=104: $200, not $600. Positive: 94 < S < 106; not all maximum.
  6. Minimum: −$2.50/share at 95–105. Break-evens: 92.50 and 107.50.
  7. Max: $250 for 95 ≤ S ≤ 105. At S=106: $150, not $250. Positive: 92.50 < S < 107.50.
  8. Profit region ≠ maximum region
  9. For the short pairs, break-even endpoints have zero profit. Interior profit need not equal the full opening premium. Shading shows positive short expiry profit; the marker or thick plateau identifies the maximum.
  10. Only stock prices 80–120 are drawn. The uncovered short call’s upward loss is unbounded. Stock-price downside is bounded by zero, but short-pair downside loss can still be substantial. Curves exclude fees, interest, dividends, taxes, early assignment and resulting positions.
  11. Education only. Not a trade recommendation.

Illustrative diagram constructed for teaching. Not real market data.

Fictional matched stock-option expiry payoffs, all y values in dollars per share (×100 per matched pair). Matching long and short curves are opposites before costs. The short straddle’s full $600 premium profit occurs only at 100; the short strangle’s full $250 occurs from 95 through 105. Outer break-evens enclose a wider positive-profit region. Fees, exercise/assignment and resulting positions are outside these ideal curves.

What this does not tell you about straddles and strangles

  • Whether either pair is attractively priced or appropriate for anyone.
  • That a large move guarantees a long pair’s profit before expiry; price, time and implied-volatility changes interact.
  • That being inside the outer expiry break-evens earns the short pair its full premium.
  • That an expiry payoff graph caps cash needs or losses after exercise/assignment creates a different position.
  • Actual commissions, margin, adjusted deliverables, tax or a broker’s exercise procedures.

For payoff mechanics see Option Payoff Diagrams. For operational consequences see Exercise, Assignment and Settlement. The calculations here are educational illustrations, not trade recommendations.

Method in Practice: an event plan, and the IV crush

Fictional example. John, Harbor Index futures, the prices, times, costs and results are all invented for teaching. This shows how a written plan can be built and tested. It is not a recommendation, and nothing here says how often this idea works.

Try it on a real chart. Test this idea yourself on past sessions with bar replay. Keep your own count, including the days with no trade.

The idea. A long strangle gains from a big move but loses value as time passes and implied volatility falls, often right after an event (this lesson). John buys one before a scheduled event only if the total cost fits his cap, and sells it the morning after, whatever happens.

John's plan (Harbor Index ETF at $100)

Setup
a scheduled event after the close
Enter if
the 102 call + the 98 put cost $1.45 or less. Buy 1 of each
Wrong if
the planned maximum loss is the whole cost
Manage
sell both at market at 09:00 the next morning
Risk
$150 maximum: $135 cost + $2.60 commissions = $137.60

Three outcomes

  • Big move: ETF to $104.50. Sold for $2.57 → +$119.40

  • IV crush: ETF up 1.2%. Both options lost value as IV fell → −$109.60

  • No trade: the pair cost $1.90, over the plan's limit → $0

Show the full replays
ReplayWhat happenedResult after costs
ABought the 102 call ($0.70) + 98 put ($0.65) = $1.35. Next morning ETF $104.50: call $2.55, put $0.02. Sold for $2.57($2.57 − $1.35) × 100 = $122 − $2.60 = +$119.40
BSame cost. Next morning ETF $101.20: call $0.25, put $0.03. Sold for $0.28($0.28 − $1.35) × 100 = −$107 − $2.60 = −$109.60
CThe pair cost $1.90 the day before$0

Test it yourself

  • Before each event, write the cost of the pair and the move needed to break even.
  • Log the IV before and after each event in your sample.
  • Count the events where the move was big enough, and the ones where it wasn't.

Where it breaks

Reflection question: What move does your options trade need just to break even after costs?

Check yourself

  1. In the 100-strike short straddle, why is profit at $104 equal to $200 instead of the $600 opening premium? What remains after the example’s $4 total pair cost?
  2. In the 95/105 short strangle, identify the maximum-profit region and the two break-evens. Why is $106 profitable but not a maximum?
  3. At $94 expiry, calculate the short strangle’s profit before costs and the matching long pair’s profit at the same premium.
  4. Does the short call’s loss stop at the opening premium if the stock keeps rising? Hint: what happens to the call side if price rises far?
  5. A separate fictional matched long straddle has both strikes at 50 and total premium 4 per underlying unit. What are its two expiry break-evens, before costs? Hint: strike plus and minus total premium.
  6. For matched underlying, expiry, contract terms and observation time, why can a long out-of-the-money strangle cost less than an at-the-money straddle? Is that a universal claim about every quoted pair? Hint: where are the strikes?

Reflect on your own process

For your own notes; there is no score and no right answer.

  1. When you write up a two-leg position, does your journal separate premium received from net profit at expiry?
  2. Which assignment and funding questions does your written checklist ask before any short option position is recorded?
  3. How would you check a break-even you computed against a second method before noting it?
  4. What move does your options trade need just to break even after costs?

Sources

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