Short Straddle

Short Straddle

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Short Straddle

Description – Short Straddle

The Short Straddle is precisely the opposite of a (Long) Straddle.
We short ATM puts and calls with a short time to expiration in order to pick up income.
Each leg of the trade has uncapped downside.
If the stock starts going ballistic in either direction, then your position is precarious to say the least.
If the stock remains range bound, then we’ll make a limited profit.
One thing to note is that you would never trade this strategy right before a news event like an earnings report.
Sell ATM strike puts, preferably with one month or less to expiration.
Sell ATM strike calls with the same expiration.

Context - Short Straddle

Outlook

With Short Straddles, your outlook is direction neutral—you are looking for no movement in the stock.

Rationale

To execute a direction-neutral income strategy for a net credit while expecting a future decline in volatility.
Ideally you are looking for a scenario where the immediate Implied Volatility has been high, giving you above average options premiums, but where you anticipate the stock to consolidate (become less volatile) and
remain range bound for the duration of your trade.

Net Position

This is a net credit trade because you have sold calls and puts.
Your maximum risk on the trade itself is unlimited, whereas your maximum reward is limited to the net
credit you receive for selling the calls and puts.

Effect of Time Decay

Time decay is helpful to short straddles.
Because you are short in options, and because you are exposed to unlimited downside, you want to be exposed to this position for as little time as possible.

Time Period to Trade

At least months out.

Breakeven Down = [Strike – Net Credit]
Breakeven Up = [Strike + Net Credit]

Steps to Trading a Short Straddle

Steps In

Try to ensure that the trend is range bound and identify clear areas of support and resistance.
Try to ensure that no news is coming out soon for the stock.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
Close the losing side by buying back the relevant option if the stock breaks support or resistance.
Buy back both options if the position is profitable but you think news may emerge about the underlying stock.

Exiting the Trade - Short Straddle

Exiting the Position

With this strategy, you can simply unravel the spread by buying back your calls and puts.

Mitigating a Loss

Buy back your sold options.
Advanced traders may consider buying further OTM calls and puts on either side in order to create a Long Iron Butterfly, which is more conservative.

Advantages and Disadvantages

Advantages

Profit from a range bound stock.
Comparatively high-yielding income strategy

Disadvantages

Uncapped risk if the stock moves in either direction.
Capped reward.
Almost certain exercise at expiration.
Bid/Ask Spread can adversely affect the quality of the trade.
High-risk strategy; not for novices or intermediates.

Share this Content

Derivatives Analysis

Basic Option Strategy