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Short Straddle _spread_

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					                                                                                                                  OPTION STRATEGIES 
 

Short Straddle (spread)
 
           STRATEGY : The short straddle position is created when an investor sells the same number of call and put
                      options at the same strike price and expiration date. This strategy is best used on sideways or
                      stagnant stocks. Unlike the Long Straddle which takes advantage of stock moves in either
                      direction, the short straddle strategy is dependant on the stock price staying at the set strike
                      price of the options at expiration.

                          Since the investor is selling options there is a net credit achieved once the trade is activated.
                          The maximum profit in the position is equal to the net credit. By selling both a call and a put,
                          there are both an upper break even point and a lower break even point. A profit is realized on
                          the position if the stock stays between the upper and lower break even points.

          WHAT TO DO: Sell calls at a set strike price and expiration date.
                      Sell the same number of puts at the same strike price and expiration date.
                      The max profit is the net credit (total premium received).
                      The position has both an upper break even and a lower break even.
                      Profit is realized if the stock stays between the upper and lower break even points.
                      The maximum risk is infinite in either direction .

             EXAMPLE: Stock XYZ at $48.35 per share.
                      Sell the FEB 50 Call for $1.20
                      Sell the FEB 50 Put for $2.70
                      Max. Profit =Net Credit = $1.20 + $2.70 = $3.90
                      Upper Break Even = $53.90
                      Lower Break Even = $46.10

                                                       800 $ 
                                                       600 $ 
                                                       400 $ 
                                                       200 $ 
                                  Debit / Credit 




                                                          0 $ 
                                                     ‐ 200 $ 
                                                     ‐ 400 $ 
                                                     ‐ 600 $ 
                                                     ‐ 800 $ 
                                                    ‐1 000 $ 
                                                    ‐1 200 $ 
                                                    ‐1 400 $ 
                                                    ‐1 600 $ 
                                                                  30 $  35 $  40 $  45 $  50 $  55 $  60 $  65 $  70 $ 
                                                                                      Stock Price 


          ADVANTAGE: Advantages of this strategy:

                          If the stock remains at the original stock price, both of the options will expire worthless and the
                          investor will keep both premiums (maximum profit).
                          If the stock price remains below the strike price but above the lower break even point the
                          investor will still realize a profit.

                          If the stock price remains above the strike price but below the upper break even point the
                          investor will still realize a profit.
                          An initial credit is received on the transaction so the investor does not have to put any money to
                          enter into the position.
                          No stock is actually owned. (uncovered position).
    Cautions with this strategy:

    The investor can take a loss if the stock swings quickly in one direction or the other due to
    unforseen events.

    The risk/max loss is infinite because of the obligation to buy or sell shares of stock that are not
    owned.

    Because of this risk, the margin requirements for this strategy are fairly high. Your broker may
    require you to cover both options as if they were two Naked Options, or they may require a cash
    value of the Option Strike Price plus the highest bid of the call or the put.




 

				
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posted:4/16/2010
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