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Published on Thursday, April 19, 2018 | Modified on Monday, April 26, 2021
Strategy Level | Advance |
Instruments Traded | Call + Put |
Number of Positions | 2 |
Market View | Neutral |
Risk Profile | Unlimited |
Reward Profile | Limited |
Breakeven Point | 2 Breakeven Points |
The Short Straddle (or Sell Straddle or naked Straddle) is a neutral options strategy. This strategy involves simultaneously selling a call and a put option of the same underlying asset, same strike price and same expire date.
A Short Straddle strategy is used in case of little volatility market scenarios wherein you expect none or very little movement in the price of the underlying. Such scenarios arise when there is no major news expected until expire.
This is a limited profit and unlimited loss strategy. The maximum profit earned when, on expire date, the underlying asset is trading at the strike price at which the options are sold. The maximum loss is unlimited and occurs when underlying asset price moves sharply in upward or downward direction on the day of expiring.
The usual Short Straddle Strategy looks like as below for NIFTY current index value at 10400 (NIFTY Spot Price):
Orders | NIFTY Strike Price |
---|---|
Sell 1 Put Option | NIFTY18APR10400PE |
Sell 1 Call Option | NIFTY18APR10400CE |
Suppose NIFTY is currently trading at 10400. You don't expect much movement in its price in near future. The Short Straddle strategy can be implemented by selling 10400 NIFTY Put and 10400 NIFTY Call. The net premium received by selling Put and Call Options will be your maximum profit while the losses can be unlimited if the price moves sharply in either direction.
This strategy is to be used when you expect a flat market in the coming days with very less movement in the prices of underlying asset.
Let's take a simple example of a stock trading at Rs 40 (spot price) in June. The option contracts for this stock are available at the premium of:
Lot size: 100 shares in 1 lot
Net Credit: Rs 200 + Rs 200 = Rs 400
This Net Credit is also the Max Profit under this strategy.
Now let's discuss the possible scenarios:
Scenario 1: Stock price remains unchanged at Rs 40
The total profit of Rs 400 is also the maximum profit in this strategy. This is the amount you received as net premium at the time you enter in the trade.
Scenario 2: Stock price goes above Rs 50
Scenario 3: Stock price goes down to Rs 30
Bank Nifty Spot Price | 8900 |
Bank Nifty Lot Size | 25 |
Strike Price(Rs ) | Premium(Rs ) | Total Premium Paid(Rs ) (Premium * lot size 25) | |
---|---|---|---|
Sell 1 Call | 9000 | 100 | 2500 |
Sell 1 Put | 9000 | 200 | 5000 |
Net Premium (200+100) | 300 | 7500 |
Upper Breakeven(Rs ) | Strike price of Call + Net Premium (9000 + 300) | 9300 |
Lower Breakeven(Rs ) | Strike price of put - Net Premium (9000 - 300) | 8700 |
Maximum Possible Prodit (Rs ) | Net Premium Paid | 7500 |
Maximum Possible Loss (Rs ) | Unlimited |
On Expiry Bank NIFTY closes at | Net Payoff from 1 Call Sold (Rs ) @9000 | Net Payoff from 1 Put Sold (Rs ) @9000 | Net Payoff (Rs ) |
---|---|---|---|
8000 | 2500 | -20000 | -17500 |
8400 | 2500 | -10000 | -7500 |
8700 | 2500 | -2500 | 0 |
9000 | 2500 | 5000 | 7500 |
9300 | -5000 | 5000 | 0 |
9600 | -12500 | 5000 | -7500 |
10000 | -22500 | 5000 | -17500 |
When trader don't expect much movement in its price in near future.
2 Breakeven Points
There are 2 break even points in this strategy. The upper break even is hit when the underlying price is equal to the total of strike price of short call and net premium paid. The lower break even is hit when the underlying price is equal to the difference between strike price of short Put and net premium paid.
Break-even points:
Lower Breakeven = Strike Price of Put - Net Premium
Upper breakeven = Strike Price of Call+ Net Premium
There is a possibility of unlimited loss in the short straddle strategy. The loss occurs when the price of the underlying significantly moves upwards and downwards.
Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received
Or
Loss= Strike Price of Short Put - Price of Underlying - Net Premium Received
Maximum profit is limited to the net premium received. The profit is achieved when the price of the underlying is equal to either strike price of short Call or Put.
One Option exercised
It allows you to benefit from double time decay and earn profit in a less volatile scenario.
Unlimited losses if the price of the underlying move significantly in either direction.
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