Write Straddle

A.K.A. Short Straddle

Opinion: Extremely Neutral.

Example:
Short 1 Oct 60 Call @ 5 1/8
Short 1 Oct 60 Put @ 4 1/4

Description: A Short Straddle is a combination of writing uncovered Calls (bearish) and writing uncovered Puts (bullish). Together, they produce a position which is neither, and thus, is considered neutral.

Strategy Profile: Before options, there was no way for an investor to profit directly from correctly forecasting a narrow trading range for XYZ. Instead of having an opinion about XYZ’s future direction, the spread’s profits are determined by whether or not XYZ stays within a range.

By collecting two premiums, the investor reduces the risk somewhat when compared to writing just one option (Call or Put). However, even with the additional premium, the risks are substantial if a large move occurs.

When to use: The investor should select this position only if XYZ is expected to trade within plus-or-minus 10% of $60 over the next 90 days.

Many investors continually forget that selection of the proper strategy must address the expected price movement of XYZ over time and the financial impact of unexpected outcomes! The Short Straddle is a strategy that could have serious financial results if XYZ moves substantially away from the strike price, e.g., as a result of a takeover bid (up) or poor earnings (down).

Profit & Loss Characteristics: The maximum potential profit point is at the strike price (60) at expiration, and large potential losses exist in either direction if XYZ should move too far.

Because stock ownership is possible due to the written Put, the downside risk can be large if XYZ has a large decline before expiration.

To the upside, the risk can be large because the written Call option becomes similar to a short stock position beyond the break-even point.

Break-even Points:
Upside: Strike + premium received.
Downside: Strike – premium received.

Time Decay: Positive. If XYZ is near the strike price ($60), profits from decay accelerate most rapidly over time. If XYZ stays near $60 for some time after position is established, investor may decide to close out position and realize the gains.

Volatility: An increase in volatility is a negative for the spread. The impact will depend to a large part on both the amount of time left until expiration and the price of XYZ relative to the strike price.

Because an increase in volatility can have a large negative impact, it is important that the implied volatilities of XYZ’s options be near historic highs before an investor consider writing a straddle!

Assignment Risk: In that this spread contains two uncovered (naked) options, the investor must watch XYZ for possible assignment if XYZ is either significantly above or below the strike price as expiration approaches.

By monitoring the time premium of the in-the-money option, the investor can determine the likelihood of assignment.

Strategy review: This strategy is reviewed, not as an endorsement, but in the recognition that it might be suitable for a small number of pretty nimble traders. Experience and control of position size are crucial.

Because of the risks, it is suggested that the investor consider altering the position in order to reduce exposure.

One alternative is to purchase the 65 Call. This caps the upside exposure, leaving a position equivalent to a long stock position should XYZ decline.