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.
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.
Limited Profit
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.
Net Premium Received - Commissions Paid
Profit achieved when: Price of Underlying = Strike Price of Short Call/Put
Unlimited Risk
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.
Unlimited
Loss occurs when: Price of Underlying > Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Short Put - Net Premium Received
Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid
Breakeven points
Strike Price of Short Call + Net Premium Received
Strike Price of Short Put - Net Premium Received
Example
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.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
Long Straddle
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.