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Short Straddle Option Strategy

Short Straddle Option Strategy

What is Short Straddle Option Strategy?

  • Short Straddle is just opposite Buy Straddle and is a range bound strategy that aims to make money wherein you don't expect underlying to show any significant movement or expecting fall in volatility (lower price swings). Short Straddle strategy demands underlying not to move significantly i.e., this is non directional strategy. In other words, if the underlying fails to show a significant directional move and closes at sold strike, we'll keep all the premium as both options expire worthless. This means,the assumption is made that the underlying price movement would be under a lull, a forecasted low volatility regime.

When to Execute Short Straddle Option Strategy?

  • Short Straddle is a non-directional strategy, but trade must also be bearish on volatility. It is advised that short Straddle should be implemented when there is no event in near term, and volatility is on the higher end and expected to decrease or can be implemented on low Volatile underlying, especially when volatility of an underlying is too low and sticky on the lower end. Short Straddle generally Implemented by options traders on expiry day, more specifically weekly expiries.

What is the Trade?

  • Under Short Straddle we Sell one lot of At-the-Money (ATM) Call and Put for the same underlying, same strike price, i.e. ATM and same expiry.

Break-Even Point

  • Short Straddle will have 2 break-even points. The breakeven points can be calculated as given below. Lower Breakeven = Strike Price - Net Premium Received. Upper Breakeven = Strike Price + Net Premium Received.

What will be maximum profit?

  • Maximum Profit is only at sold strike price i.e., ATM strike.

What will be your maximum loss?

  • It is a Net credit strategy as we have sold both Call option & Put option. Maximum Loss is undefined If the underlying stays between higher and lower breakeven, the straddle option trading strategy remains profitable.

What are the advantages?

  • Profit from Range bound stock. 1. Profit from range bound stock. 2. Comparatively high yielding income straddle option strategy as compared to Short Options Strangle and Short Guts. 3. Provides less range of profitability. 4. Time decay is beneficial.

What are the disadvantages?

  • Uncapped Risk on either side. Hedging cost would be high if stock gives any directional movement..

Example of Short Straddle:

  • Nifty future fair price 2 Feb 2023 expiry is 18188
    Short Straddle can be devised by selling
    one lot of 18200 CE @ 143.35
    one lot of 18200 PE at Rs. 157.65
    For expiry: 2 Feb 2023.
    Net Premium Received = Rs301.
    So, Net premium received effectively is Rs 15050/- (lot size = 50)
    Undefined loss potential begins when, if Nifty moves above or below the upper or lower breakeven i.e., 17899 and 18501. Max Profit if underlying closes at 18200. The payoff profile on expiry, resembles an inverted V.

Impact of volatility change:

  • When volatility increases, short straddle option strategy , increases in price and loses money. When volatility falls, short straddles decrease in price and make money. In the language of options, it is a negative vega option strategy.

Impact of Time value decay:

  • The time value component of an option's total price decays as Days to Expiry decrease. This is known as time decay. Since short straddles consist of two short options, the sensitivity to time erosion is higher than for single-option positions. Short straddles tend to make money rapidly as time passes and the stock price does not fluctuate much.