What is a Bear Straddle
A bear straddle is a speculative derivative option trading strategy where the trader buys a short call and short put positions with the same strike price and expiration date. The bear straddle trade requires no movement in the underlying asset to return a profit. Profit happens if there is no movement in the price of the underlying asset.
BREAKING DOWN Bear Straddle
Unlike a typical short straddle, the strike price of a bear straddle is above the current price of the stock. The put end of the straddle begins the trade in the money (ITM) while the call end starts out of the money (OTM). The purchaser of a bear straddle believes that the price of the underlying asset will not move. This belief is the reasoning behind buying a short put and a short call position.
Holders of a bear staddle position profit only if there is no movement in the price of the underlying asset. However, if there is a broad movement either up or down, the trader could face substantial losses and be at risk of assignment. When an options contract is assigned, the option writer must complete the requirements of the agreement. If the option were a call, the writer would have to sell the underlying security at the stated strike price. If it were a put, the writer would have to buy the underlying security at the stated strike price.
The Cautionary Tale of Bear Straddle Gone Bad
Banks and securities firms sell bear straddles and other short straddles, to earn substantial profits during times of low volatility. However, the loss of such a trade strategy can be limitless. Proper risk management is paramount. The story of Nick Leeson and the British merchant bank, Barings, is a cautionary tale of improper risk management practices for the sale of straddles.
Nick Leeson, was the general manager of Barings trading business in Singapore, was tasked with looking for arbitrage opportunities in Japanese futures contracts listed on the Osaka Securities Exchange and the Singapore International Monetary Exchange. Instead, Leeson made unhedged, directional bets on the Japanese stock market. He quickly began losing money. To cover these losses, Lesson started selling straddles related to the Nikkei. This trade was effectively betting that the stock index would trade within a narrow band. After a January 2018 earthquake struck Japan, the Nikkei sank in value. This Leeson trade and others cost the bank more than $1 billion. The incident led to the takeover of Barings bank by Dutch bank ING for £1.