A straddle is an investment strategy in options with which the investor holds a position in both a call and put with the same strike price and expiration date. A long straddle involves going long, i.e., purchasing, both a call option and a put option on the same underlying. A short straddle is a non-directional options trading strategy that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date.
a) Under what circumstances and belief, would an investor consider a long or short straddle position? Give a recent example of a situation that would be a good opportunity for a straddle on Turkish interest rates or lira.
b) How would you use a straddle position to bet on the volatility of the underlying?
c) One analyst quips:
"One of the frustrating things about buying straddles is that the more correct you are, and the more quickly you are proven correct, the more quickly your position loses the ability to profit from volatility. A straddle opened as a bet on volatility quickly becomes a simple long/short bet on the underlying asset: straddles run out of gamma too quickly."
What does the above quote mean with this warning about straddles? Explain by thinking about your position and its risks as the underlying moves over time.
d) Related to part c, what is your cost to hold a long straddle becomes as the underlying moves in time? Explain using the appropriate Greeks and their relationships. What about the capital tied to the position?