Explanation

Short straddle is opposite of long straddle and is one of the most commonly used option strategies in the neutral market to earn premium. This option strategy is used when the trader see no major movement in the market in near term and expect market to trade in a range. This is option selling strategy and is executed for net credit, which involves selling call and put options. Call and Put option should be of same strike price, same expiry date and of the same underlying asset.

Profit potential is limited to the total premiums received less charges.The option seller will only make money if the underlying security stays in a range of sold option strike price, resulting in loss of premium paid by the buyer. Potential loss is unlimited and such situation will come true if the underlying closes volatile at expiry, the trader will make losses in access to the premium received.

Risk:

Unlimited

Reward:

Limited

Construction

Sell 1 Call Option

Sell1 Put Option

Payoff Chart

Example

Suppose the Bank Nifty index is trading at 42800 levels and the trader is bearish on the volatility of the underlying and expect the index to trade in a tight range till expiry. He implements short straddle option strategy. He sold 42800 call at premium of 200 and 42800 put at a premium of 165. The net premium received while implanting this strategy would be Rs. 9125. [(200+165)*25]

Scenario 1:

At expiry if Bank Nifty stays in close range of 42800 the trader will make profit as both the call and put option will expire worthless. Max profit will be equal to the net premium received.

Scenario 2:

Opposite to the above scenario, if the index makes a volatile move to the upside or downside. The trader will lose in access to the breakeven point, which is mentioned above.