One of the issues with studying options is that any overview of options is going to include all the basics—and, let’s be honest, if you’re prepping for a Wall Street job, you should know the basics.
If the advanced stuff weren’t so hard to remember, this wouldn’t be an issue, but again, let’s face it—the advanced stuff is difficult not because the concepts are intrinsically complicated, but because there are a lot of rules that need to be tackled from different perspectives.
To explain what I mean, consider straddles and spreads. Remembering that straddles are bets on volatility is easy—both have the letter L in them—and spreads are bets on price for the same reason. But you’ll need to remember how to identify and calculate these combinations, and that is where things get a bit tough.
Straddles involve two opposing options—think of them as straddling between calls and puts, hence the name. Straddles will have identical strike prices and expiration dates, and they have two breakevens: the strike price plus and minus total premiums paid. Now we have some unifying features we can put together:
Straddles are:
1. Bets on volatility
2. Combinations of a put and call
3. Two strike prices (+/- total premiums)
Now things are a little harder when we need to consider long and short straddles, because they differ. Fortunately, they are mirror images of each other when it comes to attitude, max loss, and max gain, which does make things a bit easier.
If you are betting on volatility, you have unlimited max gain and if you are betting against volatility, you have unlimited max loss. This is easy to remember if you remember that volatility can be infinite. We can add this to our list above:
Straddles are:
1. Bets on volatility
2. Combinations of a put and call
3. Two breakevens (+/- total premiums)
4. Exposed to volatility’s infinite potential (upside or downside)
If we remember this and understand the concepts behind it, we can immediately know that a long straddle has infinite upside (it’s betting on volatility’s infinite potential) and a short straddle has infinite downside. Another way to think of this: volatility in life means going up takes a long time but going down can be a short ride. Who said pneumonic devices can’t involve a bit of existential angst?
Another simple way of looking at straddles is that someone is paying to bet on volatility, and when you pay to make a bet you can only lose as much as you bet. Thus a long straddle is putting up at risk only the total premiums paid.
However, since they are mirror images of each other, it means that the long straddle is betting against the short straddle, so if the long straddle’s risk is the premiums paid, the short straddle’s gain is the premiums received. Think of the premiums as quantity p that you’re trying to turn into an unlimited result u, or p —> u. Thus p is the opposite of u in this formulation, so we can add a fifth rule.
Straddles are:
1. Bets on volatility
2. Combinations of a put and call
3. Two breakevens (+/- total premiums)
4. Exposed to volatility’s infinite potential (upside or downside)
5. Straddles attempt to turn premiums into an unlimited result
Remember these five rules, and straddles are obvious to calculate. Let’s look at an example:
BOT 1 ABC September 50 call @ 3
BOT 1 ABC September 50 put @ 2
This is a purchased combination of a put and call so it is a bet on volatility known as a straddle, and it was purchased so it is long (rules 1 & 2). Breakevens are 50-5 and 50+5, so 45 and 55 (rule 3). The total premiums paid are 5, thus that’s the maximum loss and maximum gain is infinite (rules 4 & 5).
In most textbooks this information is laid out in a table like the following:
| Position | Attitude | Max Loss | Max Gain | Breakeven Points |
| Long Straddle | Betting on Volatility | Total Premiums Paid | Infinite | Strike Price ± Total Premiums Paid |
| Short Straddle | Betting against Volatility | Infinite | Total Premiums Received | Strike Price ± Total Premiums Received |
This is typically how textbooks present the information—just staring at it won’t help! Understanding the logic of why these are the way they are can help you internalize the relationships of these two option combinations more than rote memorization or even practice questions—although the latter is very important in aiding memory. However, the Series 7 exam in particular is worded very carefully to force you to think, and if you haven’t internalized the logic of options you may find it hard to see the actual question they’re asking, resulting in missed points.