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Short Straddle Option Strategy - Advance Level Strategy - Learn How and When to Execute



Short straddle is the exact opposite of Long Straddle. Short straddle is deployed when investor expects small or no movement in the price of underlying asset. It is considered as an advanced level option strategy. Short straddle is also known as Sell Straddle or Naked Straddle.


To implement Short Straddle strategy, investor:

1. SELLS a PUT Option and

2. SELLS a CALL Option


Keep in mind that both options have same underlying asset, same strike price and same expiry.


For instance, spot price of a stock is Rs 600 and an investor sells a call and a put option at Rs 600 and receives a total premium of Rs 165.


Further, there can be different scenarios leading to profit or loss for the investor. Also, remember that the fair value of options varies as per this price movement.


Fair Value of Call Option = Spot Price - Strike Price

Fair Value of Put Option = Strike Price – Spot Price


Case 1: Spot Price falls below the strike option

Spot Price: Rs 270

Now, the value of call option is Rs -330 (Rs 270 – Rs 600) which will be considered as zero as the buyer of the call option will not exercise its option and let go the premium paid as his/her loss and the value of put option is Rs 330 (Rs 600 – RS 270) which is a loss for the investor as he has already sold the put option and buyer of put option will happily exercise the option as he has sold the underlying asset at Rs Rs 600 and now he has to buy it at just Rs 270.


Therefore, Net Payoff (LOSS) is Rs 165 (Rs 165 – Rs 330).


Case 2: Spot Price is equal to breakeven i.e. strike plus less premium received

Spot Price: Rs 435

Now, the value of call option is Rs -165 (Rs 435 – Rs 600) which will be considered as zero and the value of put option is Rs 165 (Rs 600 – RS 435) which is a loss for the investor as he has already sold the put option.


Therefore, Net Payoff is zero (Rs 165 – Rs 165).


Case 3: Spot Price remains same

Spot Price: Rs 600

Now, the value of both options is zero (Rs 600 – Rs 600) as buyers of both option will not exercise the options , however investor has received premium of Rs 165 by selling these options


Therefore, Net Payoff (PROFIT) is Rs 165 (Premium Received)


Case 4: Spot Price is equal to breakeven i.e., strike price plus premium received

Spot Price: Rs 765

Now, the value of put option is Rs -165 (Rs 600 – Rs 765) which will be considered as zero and the value of call option is Rs 165 (Rs 765 – Rs 600) which is a loss for the investor as he has already sold the call option.


Therefore, Net Payoff is zero (Rs 165 – Rs 165).


Case 5: Spot Price is above Strike Price

Spot Price: Rs 930

Now, the value of put option is Rs -330 (Rs 600 – Rs 930) which will be considered as zero and the value of call option is Rs 330 (Rs 930 – Rs 600) which is a loss for the investor as he has already sold the call option.


Therefore, Net Payoff (LOSS) is Rs 165 (Rs 165 – Rs 330).


Spot Price: Rs 1095

Now, the value of put option is Rs -495 (Rs 600 – Rs 1095) which will be considered as zero and the value of call option is Rs 495 (Rs 930 – Rs 600) which is a loss for the investor as he has already sold the call option.


Therefore, Net Payoff (LOSS) is Rs 330 (Rs 165 – Rs 495).


Summary:


Here, it can be noticed that this strategy has two break evens: upper breakeven and lower breakeven. In the given example, Upper Breakeven Price is Rs 435 whereas the lower breakeven is Rs 765.


Along with this, it can be seen that potential downside i.e. loss is unlimited depending on the price movement whereas potential upside i.e. profit is limited to the total premium received. In the given case, maximum potential profit is Rs 165 which will happen only if the spot price remains same.


Thus this option strategy is considered advanced as it involves higher risk and also requires in-depth


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