Options Trading Strategies: Short Straddle

Explanation

This strategy is just the opposite of a Long Straddle. A trader should adopt this strategy when he expects less volatility in the near future. Here, a trader will sell one Call Option & one Put Option of the same strike price, same expiry date and of the same underlying asset. If the stock/index hovers around the same levels then both the options will expire worthless and the option writer (i.e. trader) will get the premium. However this is a very risky strategy. If the price moves up or down sharply then the losses will be significant for the option writer (trader). So this strategy should be implemented only if you are ready to take calculated risk i.e. it should be precisely quantified.

Risk: Unlimited

Reward: Limited

Construction

Sell 1 Call Option
Sell 1 Put Option

Example

Suppose NIFTY is trading around 5200 levels, Mr. X does not expect the market to move sharply in the near future and implements a Short Straddle Strategy. He will sell one 5200 Call Option for a premium of Rs. 100 & sell one 5200 Put Option for a premium of Rs. 80. Lot size of NIFTY is 50. His account will get credited by Rs. 9000. [(100+80)*50]

Case 1: At expiry if NIFTY closes at 5000, then Mr. X will make a loss of Rs. 1000. [{(100) + (80 - 200)}*50]

Case 2: At expiry if NIFTY closes at 5250, then Mr. X will make a profit of Rs. 6500. [{(100-50) + (80)}*50]

Case 3: At expiry if NIFTY closes at 5400, then Mr. X will make a loss of Rs. 1000. [{(80) – (200-100)}*50]

Payoff Chart