Short Straddle
A Short Straddle is an advanced options trading strategy where a trader sells a call option and a put option simultaneously with the same strike price and date of expiry on the same underlying asset. This strategy is applied when a trader expects the underlying asset's volatility to be low and thereby expects that the stock price will remain more or less in a stable range.
The Short Straddle Setup
Suppose XYZ Corp is trading at $50 per share. To do a Short Straddle, you might sell:
Sell a call option with a strike price of $50 and receive a premium of $3.
Sell a put option with the same strike price of $50 and receive a premium of $3.
Both options will have the same expiration date, usually a few months from now, to maximize time decay.
Who Should Consider It
The Short Straddle strategy works best for savvy traders who don’t expect great volatility in an underlying asset. It is indeed very attractive, especially in the case of stable market conditions and when significant changes are not envisioned in the nearest future.
Strategy Description
The trader receives the maximum profit from the strategy in the form of premiums, which he earns at the onset of selling a call and a put. It is hoped that the price of the asset stays close to the strike price such that both options expire worthless and the trader can retain the entire amount of premiums earned.
Breakeven
There are two breakeven points for this strategy:
- Upper breakeven point: Strike price + total premium received.
- Lower breakeven point: Strike price - total premium received.
In the above example, the breakeven points would be:
- Upper breakeven: $50 + $6 = $56
- Lower breakeven: $50 - $6 = $44
Sweet Spot
The sweet spot for a Short Straddle occurs when the stock price stays exactly at the strike price of $50 at expiration, maximizing the profit potential as both options would expire worthless.
Max Profit Potential
The profit for a Short Straddle can be as high as the premiums received when selling the options. In this case, that would be $6 per share ($3 from the call + $3 from the put).
Max Loss
A Short Straddle’s potential loss is theoretically unlimited. If the price of the stock rises significantly, the call option will be exercised forcing the trader to sell shares at far below market value. Similarly, if the price of the stock falls drastically, the put option will be exercised which means selling shares at well above market value.
Risk
The major risk is a significant movement in the stock price either up or down, which may expose the trader to significant losses.
Time Decay
Time decay (theta) is favorable to this strategy. As expiration approaches, the value of the options decreases, thereby increasing the likelihood that they will go worthless and the trader can retain the premiums.
Implied Volatility
Low implied volatility at the entry point of a Short Straddle is best because this makes it cheaper to buy them back, in case the need arises. Implied volatility going higher can increase the value of options, and will threaten the seller of such an option. Vice versa, when volatility lowers after entering the straddle, the value of the options will be lower, thus favoring the seller.
Conclusion
High Potential Reward A Short Straddle presents huge premium-gathering opportunities. The risk however, is highly exposed to enormous price movements and the trader requires effective management along with clear insights about market conditions, so one should be alert and ready for an immediate move if there occurs a movement adverse to him or her. Even more than premiums earned, potential losses could overrun these when market movement happens with speed.