Earn Profits with Zero or Minor Volatility in the Index with Short Straddle Tradeoff
You can set up long straddles around significant events. The outcome of these events should be drastically different from the overall market expectation, making it difficult to expect the market to make similar swings regularly. The Short Straddle becomes a better alternative at this point.
Short straddles are most effective when the market prediction remains in a range and does not suddenly jump in value. However, many traders are afraid of short straddles because they have unlimited losses on either side. But short straddles aim to profit from minor or no volatility in the underlying stock's price.
What Is a Short Straddle?
A short straddle is a tradeoff involving selling a call and a put option at the same strike price and expiry date. Traders can use it when they feel that the underlying asset will not move significantly upwards or downwards throughout the options contracts duration. Investors can earn a maximum profit equal to the premium collected by writing the options. Because the potential loss is limitless, this is often a technique for more experienced traders.
The Short Straddle Methodology
Short straddles enable investors to benefit from the underlying investment's lack of movement rather than having to place targeted options expecting a significant swing either upwards or downwards. At a trade launch, you can acquire premiums to have both the put and call expire worthlessly. However, the odds of the underlying asset closing precisely at the strike price at expiration are slim, putting the short straddle owner in danger of assignment. However, the trader will still make a profit as long as the difference between the asset price and the strike price is more negligible than the premiums collected.
This approach benefits advanced traders who want to gain from an anticipated decrease in implied volatility. If implied volatility is abnormally high without an evident reason, the call and put may be overpriced. The idea here would be to wait for the turbulence to fall before closing the account for a return without waiting for the option to expire.
Example for Short Straddle Strategy
You can build the entire game plan for Short Straddle by predicting and determining a stock's possible range of expected trading price on indices. To forecast the trading range, you can add or deduct the value of the Call or Put option to or from the security value.
Short Straddle Option—Example
| Sell 1 ABC 100 call | 33.00 |
| Sell 1 ABC 100 put | 32.00 |
| Net Credit | 65.00 |
Short Straddle —Maximum Profit
Profitability restricts itself to the total premiums received minus commissions. If the investor holds a short straddle to expiration, the stock price closes precisely at the strike price, and both options expire worthlessly, and you can make the maximum profit.
Short Straddle—Maximum Risk
Because the stock price might climb indefinitely, the potential loss on the upside is limitless. The possible loss is significant because the stock price can fall to zero on the negative side.
At expiration, the stock price reaches its breakeven point as follows:
Total premium plus strike price:
As per the example, 100.00 + 6.50 equals 106.50.
Total premium minus strike price:
Based on the example, 100.00 minus 6.50 equals 93.50
Short Straddle Profit and Loss Table
| Stock Price at Expiration | Short 100 Call Profit/(Loss) at Expiration | Short 100 Put Profit/(Loss) at Expiration | Short Straddle Profit / (Loss) at Expiration |
|---|---|---|---|
| 1100 | (67.00) | +32.00 | (35.00) |
| 1090 | (57.00) | +32.00 | (25.00) |
| 1080 | (47.00) | +32.00 | (15.00) |
| 1070 | (37.00) | +32.00 | (5.00) |
| 1060 | (27.00) | +32.00 | +5.00 |
| 1050 | (17.00) | +32.00 | +15.00 |
| 1040 | (7.00) | +32.00 | +25.00 |
| 1030 | +3.00 | +32.00 | +35.00 |
| 1020 | +13.00 | +32.00 | +45.00 |
| 1010 | +23.00 | +32.00 | +55.00 |
| 1000 | +33.00 | +32.00 | +65.00 |
| 990 | +33.00 | +22.00 | +55.00 |
| 980 | +33.00 | +12.00 | +45.00 |
| 970 | +33.00 | +2.00 | +35.00 |
| 960 | +33.00 | (8.00) | +25.00 |
| 950 | +33.00 | (18.00) | +15.00 |
| 940 | +33.00 | (28.00) | +5.00 |
| 930 | +33.00 | (38.00) | (5.00) |
| 920 | +33.00 | (48.00) | (15.00) |
| 910 | +33.00 | (58.00) | (25.00) |
| 900 | +33.00 | (68.00) | (35.00) |
The Right Time to Employ the Short Straddle Option
When there is market volatility and uncertainty among the public, it is best to join the market and execute the Short Straddle. Investors can employ this method when they believe that the underlying asset will not make a strong move in either direction.
However, if it appears that the options are overpriced, it is best not to trade in this approach. To account for unanticipated occurrences, the trader should use the technique when the options contract has a long expiry.
Another excellent opportunity to execute Short Straddle is when the value of the contract rises above what it was during the technique's initial execution since this can offset the cost of trading (transaction fees + premium paid).
Effective Market Projection
A short straddle makes money when the underlying stock's price trades in a small range near the strike price. As a result, the optimum forecast is "neutral or sideways." In the world of options, you can refer to it as "low volatility."
Short Straddle Strategies
When the expectation for the price action is to be neutral or range-bound, a short or sold straddle may be better. Straddles frequently trade between earnings reports and other well-publicized announcements that have the potential to create significant stock price changes.
It's vital to remember that the pricing of calls and puts – and thus the prices of straddles – reflect the options market's consensus judgment of how much the stock price will change before expiration. It implies that straddle sellers feel the market consensus is "too high" and that the stock price will remain between the breakeven points.
Selling a straddle may seem intriguing to some traders because they gather two option premiums. Also, the stock has to move 'a lot' before they lose money. The market is often "efficient," which means that straddle prices accurately measure the expected stock price to move before expiration. Like all trading decisions, selling a straddle is subjective and requires appropriate timing for both the sell (to open) and purchase (to close) decisions.
Three Possible Outcomes at Expiration of the Short Straddle Tradeoff
At expiration, there are three conceivable outcomes. The stock price can be at, above, or below the strike price of a short straddle.
If the stock price at expiration equals the strike price of a short straddle, both the call and the put expire worthlessly, and you cannot create a stock position.
If the stock price at expiration is higher than the strike price, the put expires worthless, and the short call is assigned, the stock sells at the strike price and creates a short stock position. If you do not want a short stock position, terminate the call (bought) before it expires.
If the stock price at the options' expiry is less than the strike price, the call expires worthless, and the short put is issued, you can purchase the stock at the strike price and create a long stock position. If you do not desire a long stock position, the put must be closed (bought) before it expires.
It's worth noting that options are automatically exercised at expiration if they're more in the money. As a result, if the stock price is "near" to the strike price as expiration approaches, one option in a short straddle is quite likely to be assigned. If a short straddle holder wishes to avoid a stock position, the short straddle must be closed (bought) ahead of expiration.
What Are the Advantages and Disadvantages of Short Straddles?
No method is perfect and comes with risks and benefits, and Short Straddle is no exception. The following are the strategy's benefits and drawbacks:
The Benefits of a Short Straddle Options Strategy
- When there is a lack of underlying volatility in the asset's price, expert traders can employ this approach to profit from Short Straddle.
- When there is a likelihood of a drop in volatility, traders might make a clear profit.
- The premium received and profit that investors can earn from a single straddle can be substantial.
Short Straddle Options Strategy Disadvantages
- The profit is restricted to the premium collected. Profits might rapidly turn into losses if the price goes too far.
- If the price goes in any direction, the potential hazards are virtually limitless.
- Because both Call and Put options have an expiration date, they cannot be held indefinitely, which means they will become worthless after a certain period.
Conclusion
If you decide to apply the Short Straddle method, it is better to first thoroughly research the market and its historical data before investing a single rupee, as the risks may be greater than the benefits. The thing to remember about short straddle is that it works best with time decay, and it works twice as well in your favor, lowering the price of both options you sold. If you close your position before it expires, it will be less expensive to acquire it.