Understanding the Sell Straddle Strategy

short straddle: Traders analyze and make informed decisions using a variety of options trading strategies developed for different market conditions.

In this article, we will look at selling straddles, one of the neutral options strategies. Let’s expand our knowledge of options strategies by understanding their working structure through the example of a short straddle strategy.

What is a Sell Straddle?

The short straddle strategy is a multi-leg options trading strategy designed to be used when a range-bound movement is anticipated in the underlying security.

This strategy involves two legs, one call option and one put option. Here, one at-the-money (ATM) put option with the same strike price and one at-the-money (ATM) call option are sold on the underlying security with the same maturity.

This strategy is useful when the underlying asset is expected to be neutral with no directional bias. To profit from this strategy, the underlying security must remain near the strike price of the option sold with minimal movement at expiration.

A short straddle strategy should be avoided when directional movement in the price of the underlying asset is expected.

erection

To develop a short straddle strategy, you must first construct the two legs of the required options.

The two legs are:

• First leg:- Sell one in cash (ATM) put option. Here, the strike price closest to the spot price is selected.
• Second leg:- Sell one in cash (ATM) call option. In this case, the strike price is the same as in the first leg.

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Let us take an example to clearly understand the above configuration.

Assume Nifty 50 is trading around 20070 which is the spot price. The market may remain sideways and the sell strike may expire closest to the option contract. Since we are confident that the market is in a range where no trend scenario is predicted, we will deploy a short straddle strategy. Here the 20070 spot price of Nifty 50 has been rounded to the nearest strike price of 20070.

The option legs for assuming spot price of nifty 50 in 20070 are as follows:

1. If you sell 1 lot of 20050 strike price put option contract, you will receive a premium of Rs 96.
2. If you sell 1 lot of 20050 strike price call option contract, you will receive a premium of Rs 148.

Here, the total premium is calculated by adding up the premiums received from both segments. In the above example, the total premium account is Rs. 244.

That is, (96+148)=244.

Because we sell contracts on both legs, the margin required to deploy this strategy is higher compared to other options strategies. In the above example, the approximate margin required to deploy this strategy across a cool 50 lots is around 1.4 lakhs.

maximum profit and maximum loss

• The strategy earns maximum profit when the underlying security expires at the strike price. It is calculated by adding the call premium and put premium. Here in one lot of Nifty there are 50 shares.

Here the maximum profit is:

= 96+148= 244 (total premium)

= 244 x 50

=Rs 12200.

• The maximum loss for this strategy is unlimited. As the market takes direction and the spot price moves away from the strike price in either direction, you start to incur losses at expiration.

Sell ​​straddle – break even point

This strategy consists of two break-even points.

• Upper Breakeven Point = Strike Price + Total Premium.

That is, 20050+244=20294. If the spot price moves beyond this point, the strategy will begin to incur losses at expiration.

• Lower breakeven point = strike price – total premium.

That is, 20050–244= 19806. If the spot price falls below this point, the strategy starts losing money at expiration.

payoff chart

From the payoff chart you can understand:

• The strategy profits if the price of the underlying security expires between the upper and lower breakeven points.
• If the price of the underlying security is above or below the break-even limit, the strategy will incur a loss.

Advantages

• If the market is expected to move sideways, this strategy can be very profitable.
• Option legs can be adjusted according to market movements for higher profitability ratios.
• This strategy reaps the benefits of daily theta decay.

disadvantage

• The margin required is quite high compared to other options trading strategies.
• If the market becomes directional, the strategy will incur losses.
• Increased volatility is detrimental to your strategy.

conclusion

After understanding the straddle option selling strategy, we will conclude that this strategy works well in range market conditions. Here you can take advantage of theta decay during expiration to get maximum profit from this strategy. If the market becomes directional, traders can suffer large losses. Once you understand this strategy better, you can adjust the option legs to improvise setups with good risk reward ratios. Profitable traders always follow risk management to make profits in the long run.

Written by Deepak M

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