Some of the traders personally think twice before going for Short Straddle but when used in the right way, it can be useful a few times compared to other strategies. So, you must learn about this strategy and how it behaves with the profit and loss under different market situations.
The Short Straddle strategy includes one short Call Option as well as one short Put Option. So these two options have the same underlying stock, same price, and expiration. If the stock trades in a narrow range just between the breakeven points then a Short Straddle is used for a net credit.
Compared to long straddle and buying the At the Money Call Option and Put Option, you must sell the ATM Call and Put option. This short strategy is set up for the net credit. So the moment you sell your ATM options, you will get the premium in your account.
Let us consider that NIFTY is 7589. And here you can take the Strike price as being 7600 ATM. The options premium is as below,
Option Premium 77 for 7600 CE
Option Premium 88 for 7600 PE
With this short straddle, you will need to sell both Call Options and Put options and then collect the premium 77 and 88. This would make the premium 165.
Please do not take the options of different underlying or have different expiration and also different strike prices, all of the above should stay the same.
Consider the below situations,
Situation 1 -
Market expiration at 7200 (losing money on put option)
In this situation, the traders suffer a big loss in the put option that would take up the entire collected premium from PE and CE. So at the 7200,
The 7600 CE may expire uselessly and that is the reason for getting the premium 77.
The 7600 PE may have the value of 400 as an intrinsic value. Once you adjust the premium amount of Rs.88 that you receive. You would lose the 312 (400-88)
Your net loss is going to be around 235 (312-77)
You will find that the call option is offset by the put option loss.
Situation 2 -
Market Expiration at 7435 (low breakdown)
This is the scenario where with the strategy you neither make the money nor lose the money.
When the 7600 CE comes to expiration, then the received premium is well-retained.
When the 7600 PE would include the 165 as an intrinsic value which also will include the premium of Rs.88. Because of this you are going to lose
The call options gain here is also offset by the put option loss. So the money we make or lose is around 7435
Situation 3 -
Market Expiration at 7600 (ATM strike price and maximum profit)
This could be one of the most positive outcomes of Short Straddle. Both options call and put will expire uselessly worth and the premium received on both of the options will stay. The gain you have is going to be almost equal to the net premium that you have received which has the Rs.165 amount.
You can earn the highest amount of money with the short straddle when the market is not in favor.
Situation 4 -
Market Expiration at 7765 (it is also called upper breakdown)
This is the situation where the strategy breaks even if there is a higher ATM Strike price.
The intrinsic value of 7600 CE will be around Rs.165 and hence the adjustment for the Rs.77 still you can lose up to Rs.88 which is 165-77.
The 7600 PE hence would also expire without any worth, so you can still get the Rs.88
Your gain of 7600 PE is therefore offset against the 7600 CE losses. In this situation, you either make money or lose it.
Situation 5 -
Market Expiration at 8000 (loss of money on call option)
In this situation, the market situation would be above the 7600 ATM mark.
7600 PE is going to expire but Rs.88 premium will be retained
7600 CE is going to have an intrinsic value of around 400 so once you adjust the Rs.77 of the premium received, you can still get a loss of Rs.323 which is calculated by 400-77
For the put option, the premium collected is about Rs.88. The loss would be around 2345 (88-323)
Here you are able to see the call option loss is noticeable by offsetting the premium received.
So, the Short Straddle is a useful strategy that includes selling the call options and putting options that have the same expiration and strike price along with the underlying asset. When the trader thinks that the move of the underlying asset will not be higher or lower than the options contracts.