Straddling meaning in Stock market

 straddling meaning is explained including the break even point straddles. Hedging means covering yourself in case your primary plans go afoul. Speculators and investors use hedging to protect themselves when securities move in the opposite direction from what they had hoped. In this article you will get the detailed information about straddling meaning and playing effectively in stocks using straddling.

Hedging a long position in stock with a long position in a put is called a straddle. The straddle is a valuable strategy when dealing with volatile situations; these may be stocks that are targeted for takeover, that may be affected by some political or natural catastrophe, or that stand to gain by some new product. You take positions in these stocks expecting them to soar. As the insiders will already be taking positions in these stocks, the stock prices will already have begun to move. When you jump in, then, you need a parachute for what if you guess wrong or the stock has already had its run? This is where the put comes in.

Breaking Even on a straddle

You purchase 200 shares of Golden Nugget stock, anticipating that it will be taken over by Mirage, Inc. You pay $3,000 for the stock. Fearing that the takeover may fall apart, you also purchase some low-priced far-out-of-the-money puts perhaps 10 at $.25 each (for a total of $250).

As luck would have it, the takeover does not occur (but does later on). The stock falls to $15 per share, and you lose $1,000. However, the puts increase in value to $1.25, while the stock declines in price. (Remember that each put represents 100 shares of stock.) That means their total value is now $1,250. As you only paid $250 for them, your profit is $1,000. The straddle has allowed you to break even despite the heavy loss on the stock.

Break-even point on the Straddle

The cost of the puts and of the shares of stock influence your break-even point on the straddle. This means the stock or the options have to move much more for you to make a profit than they would if you were long on only the stock or only the puts. However, it is worm the higher break-even point to reduce the downside risk.

The straddle is not a particularly good strategy on stocks that have a narrow trading range, such as utilities, which are rarely, if ever, volatile. The cost of constantly opening new positions on the options after the old positions expire will mount up and cancel out your dividends as well as, possibly, your capital gains.

On the more volatile or potentially more volatile issues, the straddle can be played for top dollars, with either long or short positions on either the stock or the puts.

For example, suppose that, in the above example, you hedged with 20 puts instead of 10. In this case, the profits from the puts would double to $2,000. Subtract from this the $1,000 you lost on the stock, and you come out ahead by $1,000. The takeover never occurred, but you still made money.

But if something can go wrong, it often will. Suppose in either instance, the stock just stayed where it was, or retreated too slightly and too close to the expiration date of the puts to affect any upward movement in the options. In this case, you might lose all the money you paid for the puts, plus commissions. You would also lose additional money on the closing stock transaction and/or commissions.

Put and Call in Straddle

There is another type of straddling meaning, and this involves two options a put and a call. In this case, you are long on the put and long on the call. The position is based on the premise that if the underlying stock moves sufficiently, the put and the call will move in opposite directions, and one or the other will assure profit.

The catch here, of course, is that often a stock does not move enough before the puts and calls expire and the straddle is ineffective. Puts and calls do not necessarily move in the opposite direction. Remember, these are decaying assets. As expiration dates approach, if the underlying stock does not make a substantial move in price, both the related puts and the calls will depreciate in value. Straddles, whether made of stock and options or just options, can only be successful under the following circumstance: The underlying stock must move substantially enough to offset any time decay in the options and allow either the put or the call to advance far enough to offset the cost of the straddle. straddling meaning is explained with the strategy to hedge safely in stock market.