What is Short Straddle Strategy - Basics, Advantages and Disadvantages
What, When, How, Basics, Adjustment, Advantages & Disadvantages, etc.
What is 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.
Short Straddle Basics
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 call expire worthless. However, chances that the underlying asset closes exactly at the strike price at the expiration 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.
Key Calculations
The Maximum loss when the price of the underlying asset is increasing is given by:
Loss (up) = Price of the underlying asset - the strike price of the call option - net premium received
The profit when the price of the underlying asset is decreasing is given by:
Loss (down) = Strike price of put option - the price of the underlying asset - net premium received
The Maximum Profit is the total net premium paid less any trade commissions. This loss occurs when the price of the underlying asset equals the strike price of the options at expiration.
Advantages
In a short straddle option strategy we sale options if their is no movement then Theta Decay will gives us good amount of profits.
A short straddle option strategy is useful when their is no strong directional move is expected.
If we carry overnight long straddle option strategy then also their are chances of profits due to theta decay.
A short straddle option strategy require comparatively less skills as it require no or less volatility in market if we compare to a long straddle option strategy
Disadvantages
In a short straddle option strategy the margin require is comparatively high as we short our position which exposes us for theoretically unlimited risks.
Any black swan event or some directional move can lead into bleeding on one of the legs which leads to losses.
In a short straddle option strategy if we carry overnight position without hedging then we are expose to huge Vega & Delta moves.
Bottomline
A short straddle option strategy is a huge margin option strategy to take advantage of theta decay but we will expose to huge Vega & Delta move.