A short straddle is an advanced options strategy used when a trader is seeking to profit from an underlying stock trading in a narrow range.
To execute the strategy, a trader would sell a call and a put with the following conditions:
- Both options must use the same underlying stock
- Both options must have the same expiration
- Both options must have the same strike price
Since it involves having to sell both a call and a put, the trader gets to collect two premiums up-front, which also happens to be the maximum gain possible.
Due to the two premiums collected upfront, beginners are often attracted to this strategy without realizing the risks they face.
A short straddle can result in unlimited loss potential whenever a substantial move occurs so it should be used with caution, particularly around significant market events like an earnings announcement.
The opening position of this strategy means that you will start with a net credit and you will profit if the stock trades between the lower break-even point and the upper break-even point.
Let’s take a look at Barchart’s Short Straddle Screener for December 27th.
The screener shows some interesting short straddle trades on popular stocks such as AMC, PBR, INTC, MS, MU, BP, C, ABNB, JPM, SBUX, PG, FDX, NEM, AMZN and TSLA.
Let’s walk through a couple of examples.
AMC Short Straddle Example
Let’s take a look at the first line item – a short straddle on Advanced Micro Devices.
Using the January 13 expiry, the trade would involve selling the 5 strike call and the 5 strike put. The premium received for the trade would be $164 which is also the maximum profit. The maximum loss is theoretically unlimited. The lower breakeven price is 3.36 and the upper breakeven price is 6.64. The premium received is equal to 37.27% of the stock price, which is the highest example in the table because the volatility is so high. The probability of success is estimated at 61.3%.
The Barchart Technical Opinion rating is a 100% Sell with a strongest short term outlook on maintaining the current direction.
MS Short Straddle Example
Let’s take a look at the fourth line item – a short straddle on MS.
Using the December 30 expiry, the trade would involve selling the 86 strike call and the 86 strike put. The premium received for the trade would be $207 which is also the maximum profit. The maximum loss is theoretically unlimited. The lower breakeven price is 83.93 and the upper breakeven price is 88.07. The premium received is equal to 2.40% of the stock price. The probability of success is estimated at 57.7%.
The Barchart Technical Opinion rating is a 64% Buy with a weakening short term outlook on maintaining the current direction.
FDX Short Straddle Example
Let’s take a look at one final straddle using Fedex, towards the middle of the table.
Using the January 20 expiry this time, the trade would involve selling the 175 strike call and the 175 strike put. The premium received for the trade would be $1,225 which is also the maximum profit. The maximum loss is theoretically unlimited. The lower breakeven price is 162.75 and the upper breakeven price is 187.25. The premium received is equal to 6.96%. The probability of success is estimated at 57.4%.
The Barchart Technical Opinion rating is a 48% Sell with a weakest short term outlook on maintaining the current direction.
Mitigating Risk
Short straddles involve naked options and are highly risky. They should not be used by beginner traders.
Position sizing is important so that a large loss does not cause more than a 1-2% loss in total portfolio value.
Short straddles can also contain early assignment risk, so be mindful of as it gets close to the expiration date. Also, watch out for earnings dates as stocks can make big moves following their announcement.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes.
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