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Learn how to use covered calls to reduce the price of buying a call or to hedge for the downside potential of your existing stocks.
Bullish Option | Straddles
Selling Short Straddles
Learn how to set up and profit from diagonal calendar spreads
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short straddle is a neutral strategy that is set up by SELLING an at ATM ( At the Money) call as well as an ATM Put. Because you are selling options without protective “wings”, a short straddle is an undefined risk strategy.
- – Sell ATM Call
- – Sell ATM Put
Short straddles are used to take advantage of extreme periods of high implied volatility such as corporate earnings announcements as well as other binary events. In periods of high implied volatility, premiums are abnormally elevated. And because you are, by selling options, collecting premium, you collect significantly more premium in periods of high market volatility. Higher premiums also will push out the break even points and widen the profitable zone even further.
Short straddles benefit therefore from being set up in periods of high volatility that decrease over the period of the contract and the passage of time.
The short straddle is an options strategy that consists of selling call and put option on a stock with the same strike price and expiration date.
- – Sell ATM Call
- – Sell ATM Put
The sale of an at-the-money call is a bearish strategy; and selling a put is a bullish strategy. Combining the two into a short straddle results in a directionally neutral position.
However, as the stock price changes, the trade will become directional and can suffer significant losses.
When selling straddles, profits come from the passage of time or decreases in implied volatility, as long as the stock price remains within the breakeven points of the position.
Selling straddles is very similar to selling strangles, with the only difference being that the short call and put share the same strike price.
The first profit target is generally 25% of the maximum profit. This is done by buying the straddle back for 75% of the credit received at order entry.
A short straddle realizes maximum profit when the stock price is trading exactly at the short strike at expiration. See profit and loss diagram. The strategy will profit anywhere between the break even points, but will profit most exact in the middle of the strikes.
It is highly unlikely that you will end up exactly in the middle between the strikes. For this reason, it is suggested that taking you take profits early at somewhere around 30% profit while the stock is still between the break even points.
A short straddle will collect the most extrinsic value compared to any other option selling strategy, taking partial profits on a short straddle can lead to more profits than making maximum profit on other less aggressive strategies.
A short straddle collects the most extrinsic value compared to any other option selling strategy. Your set-up will collect premium, ideally in a high implied volatility condition, from two legs.
Option Basics
Credit Spreads
- Sell ATM Call
- Sell ATM Put
- Set up for 30-45 days DTE
Vertical Spreads
How Do You Set Up a Short Straddle?
- Implied volatility (IV) plays a huge role in our strike selection with straddles. The higher the IV, the more credit we will receive from selling the options. A higher credit ultimately means we will have wider breakeven points, since we can use the credit to offset losses we may see to the upside or downside. At the end of the day, a larger relative credit results in a higher probability of success with this strategy.
- Our target timeframe for selling straddles is around 45 days to expiration. Our studies show this is a great balance between shorter and longer timeframes.
- Selling straddles can be highly profitable when the stock price doesn’t rise or fall quickly.
Option Basics
How Does a Call Option Change with Volatility and Time
A call option will benefit from :
- A rise in stock prices
- A rise in volatility
- An early rise in stock price ( time kills the stock value )
- Positive Delta – Call prices rise when the stock price increases, which benefits the call buyer. Conversely, call prices fall when the stock price decreases, which is not good for the call buyer.
- Positive Gamma – A long call’s position delta gets closer to +100 as the stock price increases and closer to 0 as the stock price decreases.
- Negative Theta – The extrinsic value of options decays as time passes, which is detrimental to a call buyer
- Positive Vega – An increase in volatility will increase the value of a call option ( indicated by positive vega ). Conversely, a decrease in volatility will decrease the value of a call option ( indicated by a negative vega
Selling a Straddle
Profit and Loss Calculations
- Max Profit Potential: Total Credit Received x 100
- Max Loss Potential: Unlimited
- Upper Breakeven = Strike Price + Total Credit Received
- Lower Breakeven = Strike Price – Total Credit Received
- Estimated Probability of Profit: Generally between 50-60%.
Buying a Call
Management and Adjustments
- With premium selling strategies, defensive tactics revolve around collecting more premium to improve our break-even price, and further reduce our cost basis.
- With short straddles, we don’t have much wiggle room because the short options are already on the same strikes. One option is to roll the whole straddle out in time, using the same strikes.
- This can be done for a credit, and we will hope for the stock price to return to our short strike by the new expiration.
Profit Zones
- Short straddles profit from very small moves
- Long straddles profit from very large moves
Probability of Profit
- Short straddles have a hight probability of profit
- Long straddles have a low probability of profit
Short Straddles vs Long Straddles
How Is a Short Straddle Different From a Long Straddle?
- Short straddles are neutral strategies that are range-bound. You are SELLING a call and a put for a premium and at the same strike price. You want the stock price to stay inside the break even points; and ideally directly in the middle.
- Long straddles are price indifferent strategies. You are BUYING a call and a put for a debit at the same strike price. Because you are LONG a call and a put, you want the price to move dramatically in either direction outside the break even points.
Option Basics
Tips and Tricks
A short straddle option will benefit from :
- Ideal strategy for the day or period before earnings.
- Good strategy for the day before expirations
- Setting up in periods of extremely high IV ( 50-80% )
- Thereafter, you want implied volatility to decrease
- Take profits at about 25-30%
With straddles, it is important to remember that we are working with truly undefined risk in selling a naked call. We focus on probabilities at trade entry, and make sure to keep our risk / reward relationship at a reasonable level.
Implied volatility (IV) plays a huge role in our strike selection with straddles. The higher the IV, the more credit we will receive from selling the options. A higher credit ultimately means we will have wider breakeven points, since we can use the credit to offset losses we may see to the upside or downside. At the end of the day, a larger relative credit results in a higher probability of success with this strategy.
Our target timeframe for selling straddles is around 45 days to expiration. Our studies show this is a great balance between shorter and longer timeframes.
Short Straddles
The Greeks
- Neutral Delta – Delta measures directional risk. For every dollar increase in the stock, the option price will increase by the delta value. The short call will have a negative delta. The short put will have a positive delta. Because they basically cancel each other out ( neutral strategy ), the overall delta is around zero. .
- Negative Gamma – A short options position gamma gets closer to 0 as the stock price increases and closer to 1 as the stock price decreases.
- Positive Theta – Theta indicates how much an option will change per day. Short contacts gain value with time and with the approach of expiration. The extrinsic value of options decays as time passes, which is beneficial to option sellers. Time decay increases as you approach expiration
- Negative Vega – Vega measures the change in the options price for every 1% increase in implied volatility. In other words, for every 1% increase in implied volatility, the option will increase by the amount of vega. Short straddles are negative as they profit from a decrease in implied volatility. Long straddles are positive as they profit from an increase in implied volatility.0
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