Short straddle

Article contents



At a glance



Setting up the strategy

  1. Sell one at-the-money (ATM) call option on the underlying stock.

  2. Sell one at-the-money (ATM) put option on the same underlying stock with the same strike price and expiration.
Ideally you want the stock to stay at the strike price.

Who should run this?

Advanced traders only.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A straddle is an options strategy in which a trader buys (or sells) a put and call option of the same symbol simultaneously. Both options must also have identical expiration dates and strike prices.

There are two types of straddles:

Straddle type
Description
Long straddle (buy) Used by a trader who thinks the security will experience considerable, short-term volatility.

To learn more, see Long straddle.
Short straddle (sell) Used by a trader who thinks the security will experience limited, short-term volatility.


Market outlook


  • Neutral

Strategy benefits

  • Can still profit if the stock price stays stagnant.
  • Allows you to enter into a position without equity since you receive an initial credit. However, you must still have enough money to cover the margin requirements.

Strategy downsides

  • Profit loss is unlimited.
  • Maximum profit is limited to the option premium received.

Short straddle example



Scenario

Let’s say that ABC shares are currently trading at $70 in September. Since you think the stock’s price will remain stagnant in the short term, you decide to employ a short straddle strategy. You sell a $70 October put option for $250 and simultaneously sell a $70 October call option for the same premium. As a result, you will be initially credited $500.

Possible results

  1. At expiration, ABC’s shares continue to trade at $70, meaning both options would expire worthless and you would get to keep the $500 credit as profit.

  2. At expiration, ABC’s shares rise in value to $85. The put option would expire worthless; however, the call option would be exercised since it expired in the money. The stock’s intrinsic value would be $15 x 100 (number of shares in option contract). Even after applying the initial credit of $500, you would still have a $1000 loss.

Profit and loss explained



Maximum profit


Maximum profit = option premium received – commissions paid

Maximum loss



When employing a short straddle strategy, significant loss can occur whether the stock moves up or down. Theoretically, if the stock price moves up, your losses could be unlimited.

There are two ways to calculate the maximum loss, depending on the direction of the stock at expiration:

  • Stock value moves upward
    Maximum loss = stock price – strike price of short call – option premium received

  • or

  • Stock moves downward
    Maximum loss = strike price of short put – stock price – option premium received

Break-even at expiration

There are two break-even points:

  • Break-even = strike price of short call + option premium received per share
  • Break-even = strike price of short put – option premium received per share

Sample calculations



  • Stock value at start of strategy: $70
  • To execute the strategy: Sell $70 put option for $250, Sell $70 call option for $250
  • Result: $500 net credit
Stock price at expiration Profit and loss calculations 
$70 $5 (option premium received)
x 100 (number of shares in option contract)
= $500 profit

$85 $85(stock price)
-$70 (strike price of short call option)
- $5 (option premium received)
x 100 (number of shares in option contract)
= $1000 loss



Note
: commission fees are not included in the above calculations.


Short straddle payoff diagram






Creating a short straddle







Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to , then enter the symbol you want to buy or sell.

Tip: if you don't know the symbol name, try entering the company name.

The default expiration date, strike price, and strategy appear. 



Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.

Action The buy or sell action is set for you when you select the strategy type.
Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Account

Specify the account you want to use to submit an order. This field will display the account you have set as your default under user preferences, or the account you have selected in any of the linked windows. See Linking and unlinking windows for details.

Order type-specific details
Limit Enter your limit price:

  • To have the price fluctuate according to real-time data, click the lock   and select either Follow ask price  or Follow bid price .
  • To choose a custom price, select Do not follow .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.




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