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optionsplaybook.com 2 - Options Playbook

Short Straddle

Short straddle option - Options Playbook

The strategy

A short straddle gives you the obligation to sell the stock at strike price A and the obligation to buy the stock at strike price A if the options are assigned.

By selling two options, you significantly increase the income you would have achieved from selling a put or a call alone. But that comes at a cost. You have unlimited risk on the upside and substantial downside risk.

Advanced traders might run this strategy to take advantage of a possible decrease in implied volatility . If implied volatility is abnormally high for no apparent reason, the call and put may be overvalued. After the sale, the idea is to wait for volatility to drop and close the position at a profit.

Options guys tips

Even if you’re willing to accept high risk, you may wish to consider a short strangle since its sweet spot is wider than a short straddle’s.

The setup

  • Sell a call, strike price A
  • Sell a put, strike price A
  • Generally, the stock price will be at strike A

NOTE: Both options have the same expiration month.

Who should run it

All-Stars only

NOTE: This strategy is only suited for the most advanced traders and not for the faint of heart. Short straddles are mainly for market professionals who watch their account full-time. In other words, this is not a trade you manage from the golf course.

When to run it

Options Playbook image 4

You’re expecting minimal movement on the stock. (In fact, you should be darn certain that the stock will stick close to strike A.)

Break-even at expiration

There are two break-even points:

  • Strike A minus the net credit received.
  • Strike A plus the net credit received.

The sweet spot

You want the stock exactly at strike A at expiration, so the options expire worthless. However, that’s extremely difficult to predict. Good luck with that.

Maximum potential profit

Potential profit is limited to the net credit received for selling the call and the put.

Maximum potential loss

If the stock goes up, your losses could be theoreticallyunlimited.

If the stock goes down, your losses may be substantialbut limited to the strike price minus net credit received forselling the straddle.

Margin requirement

Margin requirement is the short call or short put requirement (whichever is great), plus the premium received from the other side.

NOTE: The net credit received from establishing the short straddle may be applied to the initial margin requirement.

After this position is established, an ongoing maintenance margin requirement may apply. That means depending on how the underlying performs, an increase (or decrease) in the required margin is possible. Keep in mind this requirement is subject to change and is on a per-unit basis. So don’t forget to multiply by the total number of units when you’re doing the math.

As time goes by

For this strategy, time decay is your best friend. It works doubly in your favor, eroding the price of both options you sold. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.

Implied volatility

After the strategy is established, you really want implied volatility to decrease. An increase in implied volatility is dangerous because it works doubly against you by increasing the price of both options you sold. That means if you wish to close your position prior to expiration, it will be more expensive to buy back those options.

An increase in implied volatility also suggests an increased possibility of a price swing, whereas you want the stock price to remain stable around strike A.

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