Question

Explain how to build an short straddle, what are the purposes of an short straddle strategy? Build a real life short straddle for an American stock of your choice, pull the options contracts and paste them on the answer. Please explain each part of it, what the credit or debit will be for the transaction, include every detail of each option contract you will use to build the short straddle trade.

Answer 1

• Short straddle strategy consit of portfolio of 1 short call & 1 short put with same strike price for same underlying and same expiry date is known as short straddle strategy.
• It is beneficial when there is low movement either upside or downside.
• Inflow of his strategy (today) = call premium + put premium.
• Outflow of this strategy (on expiry) = either call payoff or put payoff.
• Net loss/ gain = Total premium-Payoff
• Straddle is a combination of "at-the money" call & put (if possible) or combination of call & put near to "at-the-money".

Example:

Suppose XYZ stock is trading at $40 in June. An options trader enters a short straddle by selling a JULY 40 put for $200 and a JUL 40 call for $200. The net credit taken to enter the trade is $400, which is also his maximum possible profit.

If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the JUL 40 call expires in the money and has an intrinsic value of $1000. Subtracting the initial credit of $400, the short straddle trader's loss comes to $600.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 call expire worthless and the short straddle trader gets to keep the entire initial credit of $400 taken to enter the trade as profit.

Thanks