A Word on Straddles as Neutral Strategies
Although long and short straddles differ in their response to market movement, we have chosen to list both as neutral strategies. However, since a $10 move in either direction will have the same impact on profit, the trader doesn't necessarily have a preference which way the market moves. In this sense, the trader is neutral about market direction--as long as movement occurs.
The short straddle, as the name implies, is the opposite of the long straddle. By establishing this position, you would have to be fairly certain the stock wasn't going to move in either direction because the risk on either side if you're wrong is unlimited. Fortunately, there is another position known as the long butterfly that meets the same objectives with much less risk.
Regardless, let's assess the profitability and risks of the short straddle by adapting the same basic example as the long straddle. As you will see, the graphs showing the profitability of this position are mirror images of each other. Here's what the trade might look like in the same market selling the options at the bid.
|Sell 1 80 Call @ $7.25||($725.00)|
|Sell 1 80 Put @ $6.75||($675)|
At these prices, you can sell the straddle for 14. Since you are selling two options, a call and a put, you might get a slightly better price than the bid for each individual option. But, to keep it simple, we'll assume that the prices listed above are the best bids for the straddle.
|Stock Price||Profit (L)|
The $1,400 you sell the straddle for will be your maximum profit. As before, the position is sensitive to large moves in either direction. Like the long straddle, the position has an up- and a downside breakeven point calculated as follows:
Upside breakeven: Straddle Strike + Sale Price Straddle
80 + 14 = 94
Downside breakeven: Straddle Strike - Sale Price of Straddle
80 - 14 = 66
Given this, the position will show a profit as long as the stock remains between 66 and 94. Above or below those prices, the position will begin to show unlimited losses in either direction.
View our long straddle page.
*The profit/loss above does not factor in commissions, interest, or tax considerations.