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. It is used
when XYZ is expected
to stay within a
narrow range around
$60!
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).
Risk/Reward
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
Point: 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.
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