Hi,
I understand that at any given point of the option’s life, the level of volatility can have an effect on the position value of a straddle.
However, when looking at Schweser notes i don’t get the following phrase: ''If a Straddle is bought and then volatility increases, the position is likely to rise in value, even if nothing happens to the price of the underlying. This is the real reason why we refer to a long straddle as going long volatility ‘’
Qn: If volatility (i presume of the underlying) is increasing, wouldn’t that mean that the price of the underlying would also be volatile? Hence, am not getting how the price would not have any impact
Much thanks
You purchased call option and put option with an expiry of one month from now. Strike price was the spot price of the time your purchased the options. This purchased happened at t = 0. At that time, strike = spot = 100.
From t = 0 to t = 10, volatility went sky high in the market. But, on t = 11, spot was 100 again. There is a possibility that the long on call and long on put (long straddle) are being sold in the market a higher price than what you paid at t = 0.
You go short on call and short on put and get premiums.
Profit earned in 10 days = Premium received (at t = 11) - Premium paid (at t = 0)
So, there was no change in spot (=strike) the day your purchased call and put options and the day you sold call and put options. But, you still made the profit!