Short Straddle:
How To Benefit From Motionless Underlying
Short Straddle
Strategy Description: This strategy entails selling equal number of calls and puts for the same underlying that have the same expiration date and strike price. View: It is used when you feel that the underlying is not going to have much movement from the time the option is written till the expiration date or a decrease in the volatility of the underlying. To capitalize on your view, you can therefore initiate the shorting of a straddle trade and position yourself to benefit from the situation should it turn out to be as you have predicted.
Success: In order to be successful with this strategy, you need the underlying to stay relatively motionless. Trade ideally should be initiated when volatility is high and contracting and time to expiration is short. It is useful for certain situation as it allows the trader to benefit from the time decay as it approches expiration.
Side Note: You have to be very selective and quite certain with the relative stable price performance of the underlying you choose. This strategy is therefore not popular among most traders and is only employed by perhaps the most experience trader. Traders should use short strangles if his view about the underlying is more range bound, thus giving himself more leeway for his position to be profitable. The short strangle is therefore a more common trade.
Risk and Reward: Short straddles have unlimited risk and with limited profit. The profit is limited to the total premium received from selling both the put and the call options. Risk arise as a result of the underlying moves substantially up or down.
Conclusion:
Key Elements for using Short Straddle are:
1. Expectation of relative motionless underlying.
2. Sell when volatility is high (if possible).
3. Sell with short time to expiration.
4. Unlimited Risk with Limited Reward.
Short Straddle - Short Definition from Glossary Page
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