The short straddle - a.k.a. sell straddle or naked straddle sale - is a neutral options strategy that involve the simultaneous selling of a put and a call of the same underlying stock, striking price and expiration date.
|Short Straddle Construction|
|Sell 1 ATM Call|
Sell 1 ATM Put
Short straddles are limited profit, unlimited risk options trading strategies that are used when the options trader thinks that the underlying securities will experience little volatility in the near term.
Maximum profit for the short straddle is achieved when the underlying stock price on expiration date is trading at the strike price of the options sold. At this price, both options expire worthless and the options trader gets to keep the entire initial credit taken as profit.
The formula for calculating maximum profit is given below:
Large losses for the short straddle can be incurred when the underlying stock price makes a strong move either upwards or downwards at expiration, causing the short call or the short put to expire deep in the money.
The formula for calculating loss is given below:
There are 2 break-even points for the short straddle position. The breakeven points can be calculated using the following formulae.
Suppose XYZ stock is trading at $40 in June. An options trader enters a short straddle by selling a JUL 40 put for $200 and a JUL 40 call for $200. The net credit taken to enter the trade is $400, which is also his maximum possible profit.
If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the JUL 40 call expires in the money and has an intrinsic value of $1000. Subtracting the initial credit of $400, the short straddle trader's loss comes to $600.
On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 call expire worthless and the short straddle trader gets to keep the entire initial credit of $400 taken to enter the trade as profit.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).
The following strategies are similar to the short straddle in that they are also low volatility strategies that have limited profit potential and unlimited risk.
The converse strategy to the short straddle is the long straddle. Long straddles are entered when large movement is expected of the underlying stock price.
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