Short Straddle

Introduction

While discussing the subject of the Long Straddle, we touched upon three things:

1. Most of the obvious uncertainties are priced in. So you better have a unique point of view.
2. Time is not your friend.
3. The lack of liquidity means that you are forced to put this trade on closer to expiry and that is exactly the time when θ-decay is at its highest.

What if you invert the trade? This is exactly what the short straddle is made of. You can enter this trade soon after an widely anticipated event occurs and implied-volatility is at its highest.

Construction

This strategy consists of selling a call option and a put option with the same strike price and expiration.

The θ-decay now works for you. Sell ATM nearest-expiration options, collect the carry and laugh all the way to the bank, right?

Not so fast! If the NIFTY breaks-out above 6836.50 or below 6663.50, then you are exposed to ∞ loss. It is up to you to figure out if the Rs. 4325.00 you are getting is enough compensation for insuring against the likelihood of that breakout.

Exiting the trade

Time is your friend and volatility is your enemy. When you sell insurance of this kind, you are exposed to external events that may not have anticipated and that occur outside of market hours. If you see volatility creep up, its best to exit this trade, even if at a loss.

Related articles

• Long Straddle (stockviz.biz)
• Forensics: NIFTY Options – Theta(θ) Decay (stockviz.biz)
• Forensics: NIFTY Options – Vega(κ) (stockviz.biz)
• Forensics: NIFTY Options – Implied Volatility(IV) (stockviz.biz)
• The One Man Insurance Company (stockviz.biz)