A short straddle is a non-directional options trading strategy that involves simultaneously selling a put and a call of the same underlying security, strike price and expiration date. The profit is limited to the premiums of the put and call, but it is risky if the underlying security’s price goes up or down much. The deal breaks even if the intrinsic value of the put or the call equals the sum of the premiums of the put and call. This strategy is called “nondirectional” because the short straddle profits when the underlying security changes little in price before the expiration of the straddle. The short straddle can also be classified as a credit spread because the sale of the short straddle results in a credit of the premiums of the put and call.
If a trader writes a straddle with a strike price of $25 and the price of the stock jumps up to $50, the trader would be obligated to sell the stock for $25. If the investor did not hold the underlying stock, he or she would be forced to buy it on the market for $50 and sell it for $25.
Risk = Unlimited on when stock moves above or below breakeven points.
A short straddle will always have a maximum profit potential equaling the premiums received from selling the straddle
Maximum Profit Potential = Call Premium + Put Premium
For more precision, we can use the following formula to determine the gain or loss at expiration.
Profit/Loss at Expiration = Call Premium + Put Premium – Absolute Value(Security Closing Price – Strike Price)
