Some traders will refer to the Short Straddle options strategy as a naked straddle. This is a neutral strategy which requires you to sell a put and call of the same asset and the same expiration date with the same strike price.
Short straddle strategies have a limited amount of profit and unlimited risk. This is a useful strategy when you believe that an asset will experience a small amount of volatility in the short term.
Sell 1 at the money (ATM) Call
Sell 1 at the money (ATM) Put
The maximum amount of profit a trader can hope to make from a short straddle is achieved when the stock price is at the strike price of the options sold. When this happens, the options will expire worthless and this means that the trader will be able to keep the credit as their profit.
The maximum profit can be calculated by simply taking the commission you had paid away from the premiums that you have received.
The maximum Profit will be Achieved When Price of Underlying stock is equal to the Strike Price of Short Call/Put.
This strategy has unlimited risks, which means traders can experience large losses. These losses occur when the stock price moves strongly in either direction at the expiry date. This will cause the short call, or short put to expire in the money.
To calculate the loss, you can use the following formula:
Loss = (Price of Underlying) – (Strike Price of Short Call) – (Net Premium Received) OR (Strike Price of Short Put) – (Price of Underlying) – (Net Premium Received) + (Commissions Paid).
This strategy has two different break even points. You can calculate these breakeven positions by using the following formula:
Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
Lower Breakeven Point = Strike Price of Short Put – Net Premium Received
If Google Stocks were currently at $40 and you believe that the short term stock price will remain virtually unchanged, then you can enter into a short straddle. To do this you sell a MAR 40 put for $200, and a Mar 40 call for $200. In this case the credit received for the trade is $400, this is the maximum amount of profit you can make from the trade.
If the stock price remains unchanged, and Google stocks remain at $40 at the end of March, then both of these options will expire worthless. This means that the trader can keep the initial credit of $400 as profit.
However, if the stock prices increase to $50 at expiry, then the Mar 40 put will expire worthless, but the Mar 40 call will expire in the money. This will have a value of $1000. Deducting the initial credit of $400, this means that the losses in this situation would be $600.
Looking at these complex trading strategies can be very confusing. To make it as simple as possible, all of the examples above do not include commissions. When trading for real, you will always have to pay a commission to your broker. Commissions are not typically very expensive, they should range from between $10 and $20 per trade.
However, if you are trading more often then you should look for brokers which offer volume trading discounts. Frequent trader discounts can make trading much more affordable. OptionsHouse for example only charges $0.15 per contract plus $8.95 per trade. This can make options trading much more affordable.
Short straddle may sound complicated, but it’s actually one of the easiest strategies for an intermediate trader to master. This is helpful when the stocks have little chance of volatility.