Short Straddle Option Trading Strategy
Short Straddle Option Trading Strategy Explained
What is the Short Straddle?
The short straddle is a neutral strategy, It is a multi-leg strategy which involves simultaneous selling of both a call option and a put option with same strike prices and of expiry dates of the same stock or index
This strategy is employed when traders anticipate that price will move in a range and thus to seek profit by time decay (Theta) of Option will reduce their premium.
How to trade Short Straddle Option Strategy:
- Sell Call Option: Sell a ATM or slightly ITM or OTM Call Option. (ATM Preferred)
- Sell Put Option: Sell a Put Option. of the same strike as the Call Option.
3. Short Straddle Strategy Risk and Rewards.
- Maximum Profit: Is limited to the premium received.
- Maximum Loss: Unlimited. Losses if the stock or index price moves out of the range, If the premium received is Lesser than the movement of the Stock or Index then there is no loss. You can earn slightly profit
Execution Mechanics of the Short Straddle
1. Select the Stock or Index you want to trade :
- Choose a stock or index which is moving in a range. Caution, don’t choose a stock or index which has a breakout or breakdown, or it is trading near major support or reisitance.
2. Mow to Strike Price and Expiration Date for short straddle trading strategy:
- Always choose ATM options, .
- Choose nearby expiry date. Due to theta effect the option will lose premium swiftly.
3. Order Execution:
- Execute a simultaneous sell order for both the call and put options. This can be done in a single transaction or as separate orders. But place the both orders immediately, Don’t place one order and wait for some time and then place another order/
Risk Management Strategies for short straddle option trading strategy.
1. Implementing Stop-Loss Orders:
- As this is a limited profit and unlimited loss strategy, Put a strict stop loss. If you have received 200 as premium then don’t put stop loss of 300, Your maximum stop loss should be 200. The ideal stop loss is 50% of the net premium received.
2. Short Straddle Adjustments: Rolling the Position
- If the market moves against the short straddle, consider rolling the position by repurchasing the original options and selling new ones with a later expiration date, potentially minimizing losses.
3. Adjusting Strike Prices :
- Respond to changing market conditions by adjusting the strike prices of the short straddle. This involves buying back existing options and selling new ones with different strike prices.
Favorable Market Conditions for Short Straddle Option Trading Strategy
1. Low Volatility:
- Short straddles are mostly profitable in stable markets with low volatility. This enables traders to profit from time decay without significant price movements.
2. Before Earnings:
- There is a volatility spike before earning announcements. So traders mostly apply short straddle strategy to profit from volatility.
3. Sideways Markets:
- Short straddles can be profitable in markets, which are trading in a range and hence, allowing traders to benefit from time decay.
Risks Associated with Short Straddle Strategy
1. Unlimited Loss:
- As a trader sells both a call and a put option, potential losses are theoretically unlimited if the moves swiftly in one direction.
2. Market Direction Risk:
- Significant market moves can result in major losses. Traders must be prepared to manage risk through various strategies.
3. Time Decay:
- While time decay is advantageous for short straddle. It also has a gamma risk, means if the price moves fast in one direction, the otpions premium will increase fast than the Theta