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.