A straddle sale is a type of options strategy that involves selling both a call option and a put option with the same strike price and expiration date on the same underlying asset. The seller of the straddle receives a premium from the buyer for taking on this risk. The seller hopes that the price of the asset will not move significantly above or below the strike price by the expiration date, so that both options will expire worthless and the seller can keep the premium as profit.
A straddle sale is also known as a long straddle or a neutral straddle, because it does not have a directional bias. It is used when the seller expects low volatility in the market and does not want to take any directional risk. A straddle sale can also be used to generate income from an asset that has low trading volume or is subject to low liquidity.
Some advantages of a straddle sale are:
- It has unlimited profit potential if the price of the asset stays within a narrow range around the strike price.
- It has limited risk, because it only loses money if one or both options are exercised by their buyers.
- It can benefit from time decay, which reduces the value of both options as they approach expiration.
Some disadvantages of a straddle sale are:
- It requires paying a high premium upfront, which reduces the net profit margin.
- It exposes the seller to unlimited loss potential if there is a large price movement in either direction.
- It can be affected by changes in implied volatility, which affects both call and put premiums.
A straddle sale is suitable for traders who have a strong conviction about their view on an asset’s future direction and are willing to accept low returns with low risk. However, it is not recommended for traders who are unsure about their view or who want to capture large price movements in either direction.
Basic Theory:
A straddle involves the simultaneous purchase (or sale) of both a call option and a put option with the same strike
price and expiration date. This strategy profits from substantial price movements, regardless of whether they are up or
down. A straddle sale, specifically, is when an investor sells both a call and a put option to generate premium
income.
Procedures:
- Identify the Asset: Choose an underlying asset (e.g., stock) that you believe will experience
significant price volatility within a specific time frame. - Select Options: Choose call and put options with the same strike price and expiration date.
Selling these options creates an obligation to buy (put) or sell (call) the underlying asset if the option is
exercised. - Create a Straddle in Excel:
- Set up a table in Excel with columns for option type, strike price, premium received, and profit/loss.
- Use Excel formulas to calculate premiums, profits, and losses based on potential price movements.
Explanation:
Consider a scenario where stock XYZ is currently priced at $100. You expect significant volatility due to an upcoming
earnings announcement. You decide to sell a straddle by simultaneously selling a call option and a put option with a
strike price of $100 and an expiration date one month from today.
Excel Table:
| Option Type | Strike Price | Premium Received | Current Stock Price | Profit/Loss |
|---|---|---|---|---|
| Call | $100 | $5 | $100 | – |
| Put | $100 | $4 | $100 | – |
Scenario:
- Stock Price Rises to $110:
- The call option is exercised, and you incur a loss of $10 ($110 – $100).
- The put option expires worthless, and you keep the premium of $4.
- Net profit/loss: -$6.
- Stock Price Drops to $90:
- The put option is exercised, and you incur a loss of $10 ($100 – $90).
- The call option expires worthless, and you keep the premium of $5.
- Net profit/loss: -$5.
- Stock Price Remains at $100:
- Both options expire worthless, and you keep the premiums of $5 and $4.
- Net profit/loss: $9.
Calculation in Excel:
Assuming stock price changes in cell E2, call premium in cell C2, and put premium in cell C3, you can use the following
Excel formula for profit/loss in cell D2:
=IF(E2>$B$2, E2-$B$2-C2, IF(E2<$B$2, $B$2-E2-C3, C2+C3))
Result:
- For a stock price of $110: -$6
- For a stock price of $90: -$5
- For a stock price of $100: $9
Other Approaches:
- Adjusting Strike Prices: Instead of using the same strike price, consider using different strike
prices for the call and put options. - Varying Expiration Dates: Experiment with different expiration dates to adjust the risk and
potential profit of the straddle sale.
