UK Accounting Glossary
A short straddle is an advanced options strategy used to generate income. To put on a short straddle, the trader will sell a call and sell a put of the same security with the same strike price and expiration date. The short straddle limits the trader’s profit to the premium received for selling the options, but potential losses on a short straddle are unlimited if the price of the underlying security rises or falls dramatically.
For example, an investor who wants to trade a short straddle on XYZ Inc. when that stock is trading at $60 in May might opt to sell a June 60 call and a June 60 put. To set up this short straddle, the trader may sell the calls for $3 ($3 x 100 shares=$300) and the puts for $4 ($4 x 100 shares=$400). That brings the total premium received of the short straddle to $700. For the short straddle to remain profitable, the stock price of XYZ Inc. must trade within a relatively narrow range (i.e. between $53 and $67). As illustrated in the chart, if XYZ Inc. shot up to $77, the June 60 call would be worth $17 and the June 60 put would expire worthless. The buyer of the June 60 call would exercise his option resulting in the short straddle trader needing to purchase 100 shares of XYZ Inc. at a loss of $1,700. Deducting the $700 premium received, the total loss of the short straddle is $1,000 (i.e. $1,700 – $700=$1,000). The above example does not take into account the commissions required to execute the short straddle.
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This glossary post was last updated: 5th February 2020.