Legal Definitions - spread eagle

In the context of finance, a spread eagle (more commonly referred to as a straddle) is an options trading strategy. It involves an investor simultaneously buying both a call option and a put option for the same underlying asset, with the same strike price and the same expiration date.

This strategy is typically employed when an investor anticipates a significant price movement in the underlying asset, but is unsure of the direction (whether the price will go up or down). The investor profits if the asset's price moves substantially beyond the strike price in either direction, covering the combined cost of both options.

• Example 1: Tech Company Earnings Report

  Imagine "InnovateTech," a publicly traded technology company, is about to release its quarterly earnings report. Historically, InnovateTech's stock price has shown extreme volatility after these reports, either surging dramatically on good news or plummeting sharply on bad news, but the specific outcome is unpredictable. An investor, expecting this high volatility but uncertain of the direction, might implement a spread eagle strategy. They would buy both a call option (giving the right to buy) and a put option (giving the right to sell) for InnovateTech stock, both expiring next month and with a strike price equal to the current stock price. If InnovateTech's earnings are much better than expected, the stock price could soar, making the call option very profitable. Conversely, if the earnings are disastrous, the stock price could crash, making the put option very profitable. In either scenario, the profit from one option would ideally outweigh the cost of both options, resulting in a net gain from the anticipated price swing.

• Example 2: Pharmaceutical Drug Approval

  Consider "MediCorp," a pharmaceutical company awaiting a crucial decision from a regulatory body regarding the approval of a new drug. The market expects the approval or rejection to cause a dramatic shift in MediCorp's stock price, but the outcome is uncertain. An investor believes the decision will cause a significant price change but doesn't know which way it will go. They could execute a spread eagle by buying both a call and a put option on MediCorp stock, both with the same strike price (e.g., the current stock price) and an expiration date set just after the expected announcement. If the drug is approved, the call option would become highly profitable as the stock price rises. If it's rejected, the put option would become profitable as the stock price falls. This strategy allows the investor to capitalize on the anticipated high volatility surrounding the regulatory decision, without having to predict the specific outcome.

• Example 3: Geopolitical Event Affecting Commodities

  A major geopolitical event, such as an unexpected election in a key agricultural exporting nation, could significantly impact the price of a commodity like wheat. The election outcome might either lead to policies that restrict exports (driving prices up) or boost production (driving prices down), creating high uncertainty. A commodities trader, anticipating extreme price swings in wheat futures but uncertain of the exact direction, could use a spread eagle strategy on wheat futures options. They would purchase both a call and a put option on wheat futures, both set to expire in three months with a strike price near the current market price. If the election outcome leads to export restrictions, the call option would become valuable. If it leads to increased production, the put option would gain value. This strategy allows the trader to profit from the anticipated volatility in the wheat market regardless of the specific direction of the price movement.