Monday, 15 April 2013

Short Straddle - Neutral Strategy


Short Straddle:

Short Straddle is the exactly opposite of Buy Straddle. It is used when the option trader is expecting underlying to show no large movement. Investor expects the underlying to show little volatility Upside or Downside. In this Strategy Investor is credited with a premium since he or she writes the call and put on the same underlying for the same maturity and StrikePrice

By selling two options, you significantly increase the income you would have achieved from selling a put or a call alone. But that comes at a cost. You have unlimited risk on the upside and substantial downside risk

Nifty Options Short Straddle
Sell 1 ATM Index Call
Sell 1 ATM Index Put

Investor View: Neutral direction but expecting little volatility in underlying movement.

Risk: Unlimited.

Reward: Limited to the premium received.

Higher Breakeven: Strike Price + net premium received.

Lower Breakeven: Strike Price - net premium received.

Illustration
Index
Nifty
Nifty Lot Size
50
Underlying Strike Price
5500
Call Premium
Rs 81    (Call Premium Received)
Put Premium
Rs 50    (Put Premium Received)
Higher Breakeven Point
Rs 5639 (Strike Price+Call Put premium received)
Lower Breakeven Point
Rs 5367 (Strike Price–Call Put premium received)
Nifty Short Straddle Payoff Diagram


Reward Potential
  • Profit = Limited
  • Profit Achieved When Settlement Price of Nifty < Strike Price of Long Call i.e. 5500 + Net Premium Received i.e. 131 OR Nifty Settlement Price < Strike Price of Long Put i.e. 5500 - Net Premium received i.e. 131
  • Maximum Profit = Settlement Price of Nifty = Strike Price of Short Call / Short Put

Risk Potential 
  • Max Loss = Unlimited
  • Max Loss Occurs When Settlement Price of Nifty  = Price of Nifty - Strike Price of Short Call i.e. 5500 - Net Premium Received i.e. 131 OR Strike Price of Short Put i.e5500 – Settlement Price of Nifty - Net Premium Received i.e 131 + (Brokerage + Statutory Charges Paid)



Nifty Closing Price @
Profit/Loss
5300
3450 (Profit)
5400
1550 (Profit)
5500
6550 (Profit)
5600
1550 (Profit)
5700
3450 (Profit)

Example:
Let us assume Nifty is trading at 5510 in Apr 2013. An options trader enters a Short straddle by buy Selling a Apr 5500 put for Rs 50/- and a Apr 5500 call for Rs 81. The net premium received to enter the trade is Rs 6550 ((Call Option Premium + Put Option Premium) X 50 Lot size), which is also his maximum possible profit.

If Nifty is trading at 5600 on expiration in April, the Apr 5500 put will expire worthless but the April 5500 call expires in the money and will possess intrinsic value of Rs 100,Subtracting the premium received of Rs 131, the long straddle trader's profit comes to Rs 31 X 50 Lot size i.e Rs 1550

On expiration in April, if Nifty is still trading at 5500, both the Apr 5500 put and the Apr 5500 call expire worthless and the short straddle trader  receives a maximum profit which is equal to the actual premium received Rs 6550 ((Call Option Premium + Put Option Premium) X 50 Lot size)  taken to enter the trade.



For More Information about other strategies kindly click on below links
Guide To Options Basics
Long Call
Long Put
Short Call 
Short Put
Long Straddle
Short Straddle
Synthetic Long Call