What is a call spread straddle strategy?
Straddle strategies are used when a trader predicts a strong market move, but doesn’t know whether it will move up or down.
These strategies can potentially provide a higher chance of success while protecting against heavy losses, especially when using the strategy with call spread contracts. Thanks to the anatomy of these contracts, with a built-in floor and ceiling level, they lend themselves very well to straddle strategies.
Here, you can learn all about straddle strategies, what they are, and how to apply them when trading Nadex Call Spread contracts, so you can begin setting up your own trades.
What is a straddle?
In trading, a straddle strategy involves buying and selling at the same time – it is direction neutral. To make this strategy work, the two positions selected will offset each other on a directional basis, making this a good strategy in unpredictable markets. Straddles offer the opportunity to profit, but also give a degree of protection.
How does a straddle strategy work?
Straddle strategies work by letting you take both a short and long position on a market, reducing risk and giving an opportunity to profit in any market direction. It’s a direction neutral strategy, which can help you navigate the markets without having to pick a direction.
Straddle strategies work especially well with Nadex Call Spread contracts, as they provide a natural floor and ceiling which is needed to set up the trade.
These are some of the reasons why a straddle strategy works so well:
It’s direction neutral. This strategy is carried out in two legs, so you go long and short at the same time. This means there is the potential to profit, regardless of market direction.
No stops are required. Thanks to the structure of call spread contracts, the floor and ceiling mean you will have absolute risk protection on both your long and short position. And, because the boundaries do not cause the contract to expire, or stop the trade, in some cases, where the markets move swiftly in one direction, only to reverse and move swiftly in the opposite direction, you could realize profit on both positions.
If carried out properly, this strategy should involve a very low level of risk, while offering a generous amount of potential return.
You know all possible outcomes upfront. Your order tickets will tell you what your maximum possible profit and loss levels are – to work this out for the trade in its entirety, you can simply add together the maximum potential risk and reward from the long and short contracts.
Straddle vs. strangle
Straddle strategies using call spreads are similar to strangle strategies utilizing binary options, in that both are direction neutral and give traders the opportunity to profit from markets moving up, down, or in some cases, making large whipsaws. The mechanics of executing both strategies is slightly different; however, the premise of both strategies is the same.
In both of these strategies, traders are looking for a relatively low risk, high potential return trade that takes advantage of rapid market moves, which are often unpredictable from a directional perspective.
How to trade a straddle with Nadex
The basic principle of this strategy is to buy and sell call spread contracts at the same time, taking positions on both possible market directions. Here’s an overview of trading straddles so you can learn how to set them up on Nadex:
Decide on the market you are going to trade. If you expect large market movements and lots of volatility, a straddle could be a good strategy for you.
Pick your moment. With a straddle strategy, it is best to trade before you expect volatility to occur. If you are trading around a major news announcement or economic event, you should set up your position ahead of this, so there is time for your trades to experience maximum movement, giving you the best chance of profiting.
Look at the level the market is currently trading at. You should choose spreads with a floor and ceiling that are at this level: it should be the floor of the spread you buy, and the ceiling of the spread you sell. See the example below to learn how this works in practice.
Work out your maximum risk and maximum potential profit by adding together the figures from the order tickets. If you’re happy and this works within the parameters of your trading plan, you can go ahead and place the trade.
The great thing about call spreads is that they limit your losses automatically. So even if you have hit your maximum loss, you may as well stay in the trade until expiration as the market could potentially change direction and make you a profit.
Straddle strategy example
Here is an example to illustrate how a straddle strategy would work in practice:
You are trading on the EUR/USD market, which you believe is going to experience volatility. You’re unsure of the direction this volatility could take, so you decide to approach the trade with a straddle strategy.
The market is currently trading at 1.2370. This means you need to find two call spread contracts at an equivalent price – you should buy one where 1.2370 is the floor, and sell one where it’s the ceiling.
In some cases, the price levels will not be exact; however, you will be looking for a situation when the price level of the floor of one contract and the ceiling of the other contract are as close to the underlying market as possible. The two strikes also need to expire at the same time.
You place the following trades:
Buy: EUR/USD 1.2370-1.2620 (3 p.m.) at a level of 1.2381
Max profit: $239
Max loss: $11
Sell: EUR/USD 1.2120-1.2370 (3 p.m.) at a level of 1.2359
Max profit: $239
Max loss: $11
In order for you to profit, either of the two scenarios will need to take place:
EUR/USD will move above 1.2392
EUR/USD will move below 1.2348
The market will need to move by 22 ticks in order to break even. This is because you put $22 in total into the two trades – once the market moves above or below this, in either direction, your position will be profitable at that time.
If the market makes a move in one direction, past the lowest floor or highest ceiling, the maximum potential reward is $217, excluding fees: $239 - $22.
Keep in mind two factors though. In situations where volatility is expected, the markets may move extremely fast in one direction, only to reverse and make a sizable move in the other direction.
As such, you may want to set predetermined take profit levels on each leg of this trade. One reason is that with such quick moves, if you fail to take profit and close your position, there is a chance that a once profitable trade will reverse and those profits can be easily given back.
Secondly, in the case of a market that creates a whipsaw move, it is possible that both sides of this trade could result in profit, if you exit the trades appropriately.
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