What Is a Short Straddle?
A short straddle is an options strategy comprised of selling both a call option and a put option with the same strike price and expiration date. It is used when the trader believes the underlying asset will not move significantly higher or lower over the lives of the options contracts. The maximum profit is the amount of premium collected by writing the options. The potential loss can be unlimited, so it is typically a strategy for more advanced traders.
Key Takeaways
- Short straddles are when traders sell a call option and a put option at the same strike and expiration price on the same underlying issue.
- A short straddle profits from an underlying lack of volatility in the asset's price.
- They are generally used by advanced traders to bide time.
Understanding Short Straddles
Short straddles allow traders to profit from the lack of movement in the underlying asset, rather than having to place directional bets hoping for a big move either higher or lower. Premiums are collected when the trade is opened with the goal to let both the put and callexpire worthless. However, chances that the underlying asset closes exactly at the strike price at theexpiration are low, and that leaves the short straddle owner at risk for assignment. However, as long as the difference between asset price and strike price is less than the premiums collected, the trader will still make a profit.
Advanced traders might run this strategy to take advantage of a possible decrease in implied volatility. If implied volatility is unusually high without an obvious reason for it being that way, the call and put may be overvalued. In this case, the goal would be to wait for volatility to drop and then close the position for a profit without waiting for expiration.
Example of a Short Straddle
Most of the time, traders use at the money options for straddles.
If a trader writes a straddle with a strike price of $25for an underlying stock trading near $25 per share, and the price of the stock jumps up to $50, the trader would be obligated to sell the stock for $25. If the investor did not hold the underlying stock, they would be forced to buy it on the market for $50 and sell it for $25 for a loss of $25 minus the premiums received when opening the trade.
There are two potential breakeven points at expiration at the strike price plus or minus the total premium collected.
For a stock option with a strike price of $60 and a total premium of $7.50, the underlying stock must close between $52.50 and $67.50, not including commissions, for the strategy to break even.
A close below $52.50 or above $67.50 will result in a loss.
Is a Short Straddle Bullish?
A short straddle combines selling a call option, which is bearish, and a put option, which is bullish, with the same strike price and expiration date. The resulting position suggests a narrow trading range for the underlying stock being traded. Risks are substantial, should a big move occur.
Is a Short Straddle or a Strangle Better?
A strangle is an options strategy that is used when an investor thinks the stock price is likely to move in one direction, but still wants protection just in case. Both short straddles and strangles are effective strategies depending on the objective. Straddles are better to use when it's unclear what direction the price of the stock is heading. Strangles are better to use when an investor thinks the stock is likely to move in a particular direction, but wants protection just to be safe.
What Is a Long Straddle?
With a long straddle, an investor buys a put and a call at the same strike price and expiration date. The intention is to benefit from a big move in the price of the underlying asset, often generated by a one-time or newsworthy event. The risk to this kind of strategy is when the asset doesn't react very strongly to the event, raising the likelihood that the options that were purchased expire worthless, and the trader loses money.
The Bottom Line
A short straddle is an options trading strategy in which an investor sells both a put and call at the same strike price and expiration date. The trader benefits by collecting the premium as a profit. But the trade is only effective in a market that isn't very volatile. If the market moves strongly in either direction, the trader has to cover any losses and give back the premium. As such, it's a strategy that is best employed by experienced traders.
