What is a 'Short Straddle'

A short straddle is an options strategy comprised of selling both a call option and a put option with the same strike price and expiration date. It is used when the trader believes the underlying asset will not move significantly higher or lower over the lives of the options contracts. The maximum profit is the amount of premium collected by writing the options. The potential loss can be unlimited, so it is typically a strategy for more advanced traders.

BREAKING DOWN 'Short Straddle'

Short straddles allow traders to profit from the lack of movement in the underlying asset, rather than having to place directional bets hoping for a big move either higher or lower. Premiums are collected when the trade is opened with the goal to let both the put and call expire worthless. However, chances that the underlying asset closes exactly at the strike price at the expiration is low, and that leaves the short straddle owner at risk for assignment. However, as long as the difference between asset price and strike price is less than the premiums collected, the trader will still make a profit.

Advanced traders might run this strategy to take advantage of a possible decrease in implied volatility. If implied volatility is unusually high without an obvious reason for it being that way, the call and put may be overvalued. In this case, the goal would be to wait for volatility to drop and then close the position for a profit without waiting for expiration.

Example of a Short Straddle

Most of the time, traders use at the money options for straddles.

If a trader writes a straddle with a strike price of $25 for an underlying stock trading near $25 per share, and the price of the stock jumps up to $50, the trader would be obligated to sell the stock for $25. If the investor did not hold the underlying stock, he or she would be forced to buy it on the market for $50 and sell it for $25 for a loss of $25 minus the premiums received when opening the trade.

There are two potential breakeven points at expiration at the strike price plus or minus the total premium collected.

For a stock option with a strike price of $60 and a total premium of $7.50, the underlying stock must close between $52.50 and $67.50, not including commissions, for the strategy to breakeven.

A close below $52.50 or above $67.50 will result in a loss.

RELATED TERMS
  1. Long Straddle

    A long straddle is an options strategy with the purchase of both ...
  2. Covered Straddle

    A covered straddle is an option strategy that seeks to profit ...
  3. Bear Straddle

    A bear straddle is a speculative options trading strategy through ...
  4. Strangle

    A strangle is an options strategy involving a call and put with ...
  5. Stock Option

    Stock options give the holder the right to buy or sell shares ...
  6. Put Option

    A put options gives the owner the right to sell a specified amount ...
Related Articles
  1. Trading

    Profit On Any Price Change With Long Straddles

    In this strategy, traders cash in when the underlying security rises - and when it falls.
  2. Trading

    Straddle Strategy: A Simple Approach to Market Neutral

    Being both short and long has advantages. Find out how to straddle a position to your advantage.
  3. Trading

    Profit From Earnings Surprises With Straddles And Strangles

    These option strategies allow traders to play on earnings announcements without taking a side.
  4. Trading

    How To Profit From Volatility

    We explain four key strategies to profit fom volatility in markets.
  5. Personal Finance

    Tips for Answering Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of the Series 7.
  6. Trading

    Strategies for Trading Volatility With Options (NFLX)

    These five strategies are used by traders to capitalize on stocks or securities that exhibit high volatility.
  7. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  8. Taxes

    How Are Futures & Options Taxed?

    We present a basic introduction to the US tax processes of futures and options.
  9. Trading

    The Basics of Options Profitability

    Learn the various ways traders make money with options, and how it works.
  10. Trading

    How To Use Options To Make Earnings Predictions

    Use this simple three-step process to make your own earnings predictions using options data.
RELATED FAQS
  1. What happens when a security reaches its strike price?

    Learn more about the moneyness of stock options and what happens when the underlying security's price reaches the option ... Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center