I’ve talked about a lot of option strategies… mostly to capitalize on some view of the underlying stock. You buy a call if you are bullish, a put because you are bearish… and the beat goes on.

But what about times when you are not certain about direction? When you would normally sit on the sidelines waiting for the market to make a new high, or better yet, go through a mild correction in order to create a buying opportunity. In many ways, probably what you are thinking right now!

Rather than sitting on the sidelines you might consider the long straddle. A long straddle is the simultaneous purchase of both a call and a put with the same strike price. For example, with XYZ at $50, you could buy a six-month XYZ 50 call (trading at $5 per share) and a six-month XYZ 50 put (trading at $4 per share) for a net debit of $9 per share.

Having purchased both a call and a put, you are no longer concerned about direction. The call makes money if the stock rises, the put profits if the stock declines. The challenge is that XYZ moves more than $9 per share, to overcome the cost of the two options.

What the straddle is really doing is framing a trading range for the underlying stock. In the case of XYZ, the six-month implied trading range is $41 to the downside and $59 to the upside. The implied trading range is defined in the options world as implied volatility.

The problem with implied volatility is that it is a percentage number, which doesn’t tell investors much. The implied trading range tells us what trading range the options market believes is reasonable for the underlying stock. As such, a straddle is really a volatility trade.

Of course you can either buy or sell a straddle. Although at this stage of the market, I think buying straddles makes more sense. First of all, you are unlikely to lose the entire cost of the straddle. With the XYZ example, the stock would have to close at exactly $50 per share on expiration day, which is not a likely scenario.

Secondly, when traders are anticipating a correction after a serious market rally – sound familiar – volatility contracts and straddles become an interesting alternative strategy. The problem with trying to pick a top when you believe the market is acting irrationally is the market can often act irrational for longer than you can afford to bet against it. The straddle, especially if the price is reasonable, can provide a short term strategy that benefits if other traders come to the same conclusion as you, but also, if market participants continue to act irrationally.