Short
Straddle
Description
The
Short Straddle is precisely the opposite of a (Long) Straddle. You short
at-the-money puts and calls with a short time to expiration (one month or less)
in order to pick up income. Because you are short options, time decay works for
you, so you only select short-term expiration dates.
Also
you are exposed to potentially unlimited risk, which is another reason for
making this a short-term strategy. The problem is that you could be successful
at it for months, picking up modest income over and over again, and then all at
once you could have one big loss which would wipe out years worth of gains. It
is not worth it.
Each
leg of the trade has uncapped downside. If the stock starts going ballistic in
either
direction, then your position is precarious to say the least. If the stock
remains rangebound, then you will make a limited profit. If the stock gaps in
either direction, you are history!
One
thing to note is that you would never trade this strategy right before a news
event
like an earnings report. You certainly would not want any nasty surprises to
be
lurking around the corner.
Market
Opinion
Directional
neutral.
P/L
When
To Use
Use
this income strategy when you anticipate a reduction in a stock’s volatility.
Example
XXXX
is trading at $25.37 on May 14, 2011.
Sell
June 2011 25 strike put for $1.20.
Sell
June 2011 strike call for $1.50.
Net
credit: premiums sold = $2.70.
Benefit
The
benefit is the possibility to garner a high yield from a rangebound stock.
Risk
vs. Reward
The
risk is unlimited. The reward is limited to the net credit you receive for
selling puts and calls.
Net
Upside
Net
credit received.
Net
Downside
Uncapped.
Break
Even Point
Strike
plus net credit.
Effect
Of Volatility
Negative
when the position is profitable, and positive when it is not profitable.
Effect
Of Time Decay
Positive.
You are in short options with unlimited downside, so you want to be in this
position for as short a time as possible.
Alternatives
Before Expiration
To
stem a loss, you can close the losing side by buying back the option if the
stock breaks through resistance or support. Of, if the trade is profitable, you
could buy back both options.
Alternatives
After Expiration
Unravel
the trade. Buy back your puts and calls.