A short straddle is an advanced options strategy used when a trader is seeking to profit from an underlying stock trading in a narrow range.
To execute the strategy, a trader would sell a call and a put with the following conditions:
- Both options must use the same underlying stock
- Both options must have the same expiration
- Both options must have the same strike price
Since it involves having to sell both a call and a put, the trader gets to collect two premiums up-front, which also happens to be the maximum gain possible.
Due to the two premiums collected upfront, beginners are often attracted to this strategy without realizing the risks they face.
A short straddle can result in unlimited loss potential whenever a substantial move occurs so it should be used with caution, particularly around significant market events like an earnings announcement.
The opening position of this strategy means that you will start with a net credit and you will profit if the stock trades between the lower break-even point and the upper break-even point.
Let’s take a look at Barchart’s Short Straddle Screener for December 6th.
I have added a filter to only include stocks with a market capitalization greater than $40b and total call volume greater than 2,000.
The screener shows some interesting short straddle trades on popular stocks such as TSLA, AMD, NVDA, PG, PLTR, BA and MSTR.
Let’s walk through a couple of examples.
TSLA Stock Short Straddle Example
Let’s take a look at the first line item – a short straddle on Tesla.
Using the February 21 expiry, the trade would involve selling the $415 strike call and the $415 strike put. The premium received for the trade would be $7,655 which is also the maximum profit.
The maximum loss is theoretically unlimited. The lower breakeven price is $338.45 and the upper breakeven price is $491.55. The premium received is equal to 18.65% of the stock price.
Keep in mind TSLA reports earnings in late January.
The Barchart Technical Opinion rating is an 80% Buy with a Strongest short term outlook on maintaining the current direction.
AMD Short Straddle Example
Let’s take a look at the fourth line item – a short straddle on AMD.
Using the January 31 expiry, the trade would involve selling the $125 strike call and the $125 strike put. The premium received for the trade would be $1,315 which is also the maximum profit.
The maximum loss is theoretically unlimited. The lower breakeven price is $111.85 and the upper breakeven price is $138.15. The premium received is equal to 10.49% of the stock price.
The Barchart Technical Opinion rating is a 100% Sell with a Strengthening short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
NVDA Short Straddle Example
Let’s take a look at one final straddle using Nvidia.
Using the January 17 expiry, the trade would involve selling the $144 strike call and the $144 strike put. The premium received for the trade would be $945 which is also the maximum profit.
The maximum loss is theoretically unlimited. The lower breakeven price is $134.55 and the upper breakeven price is $153.45. The premium received is equal to 6.54%.
The Barchart Technical Opinion rating is an 80% Buy with an Average short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
Mitigating Risk
Short straddles involve naked options and are highly risky. They should not be used by beginner traders.
Position sizing is important so that a large loss does not cause more than a 1-2% loss in total portfolio value.
Short straddles can also contain early assignment risk, so be mindful of as it gets close to the expiration date. Also, watch out for earnings dates as stocks can make big moves following their announcement.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
