What Is a Short Straddle?
A brief straddle is an options strategy comprised of selling each a call option and a put option with the identical strike price and expiration date. It’s used when the trader believes the underlying asset is not going to move significantly higher or lower over the lives of the choices contracts. The utmost profit is the quantity of premium collected by writing the choices. The potential loss may be unlimited, so it is often a technique for more advanced traders.
Key Takeaways
- Short straddles are when traders sell a call option and a put option at the identical strike and expiration on the identical underlying.
- A brief straddle profits from an underlying lack of volatility within the asset’s price.
- They’re generally utilized by advanced traders to bide time.
Understanding Short Straddles
Short straddles allow traders to cash in on the dearth of movement within the underlying asset, quite than having to put directional bets hoping for a giant move either higher or lower. Premiums are collected when the trade is opened with the goal to let each the put and call expire worthless. Nevertheless, possibilities that the underlying asset closes exactly on the strike price on the expiration are low, and that leaves the short straddle owner in danger for project. Nevertheless, so long as the difference between asset price and strike price is lower than the premiums collected, the trader will still make a profit.
Advanced traders might run this technique to reap the benefits of a possible decrease in implied volatility. If implied volatility is unusually high without an obvious reason for it being that way, the decision and put could also be overvalued. On this case, the goal could be to attend for volatility to drop after which close the position for a profit without waiting for expiration.
Example of a Short Straddle
More often than not, traders use at the cash options for straddles.
If a trader writes a straddle with a strike price of $25 for an underlying stock trading near $25 per share, and the value of the stock jumps as much as $50, the trader could be obligated to sell the stock for $25. If the investor didn’t hold the underlying stock, they’d be forced to purchase it in the marketplace for $50 and sell it for $25 for a lack of $25 minus the premiums received when opening the trade.
There are two potential breakeven points at expiration on the strike price plus or minus the whole premium collected.
For a stock option with a strike price of $60 and a complete premium of $7.50, the underlying stock must close between $52.50 and $67.50, not including commissions, for the technique to break even.
An in depth below $52.50 or above $67.50 will end in a loss.