You may wonder why someone will use this strategy. Sometimes traders get confused to enter the market when there is no significant movement in either side. Instead of waiting for the market to move, you can make money in a flat market also. Our strategy becomes very handy during these kind of situations.
So, how do you build a short straddle ? Let’s try it with an example of Nifty.
Today is Tuesday 10th Jan 2017. For the last two days, Nifty has been moving in a narrow range of 10, 15 points on a closing basis.
You could set a short straddle yesterday to benefit from this situation by
- Sell 8300 PE at 115.
- Sell 8300 CE at 66.
Now let’s check our position toady evening. Nifty has moved up 52 points and closed at 8288 today.
Let’s have a look at our position now.
- 8300 PE is 85 today.
- Your profit from this contract is 30 points.
- 8300 CE is having a value of 81.
- You have lost 15 points in this trade.
If you square off your position today you will earn a profit of ( 30 – 15 ) x 75 = Rs. 1125 from one lot of Nifty in one day.
Short straddle is a market neutral strategy. You are selling naked call and put options. Your loss will be unlimited if the market tend to move sharply in either direction.
You can use other strategies like short strangle to reduce your risk by widening the strikes. But remember any strategy involves naked option writing is highly risky.
Apply short straddle when there is a narrow range movement in the stock price. This situation arises when the stock or index had a good rally and then consolidates at certain levels for some time before starting the next leg of rally. Avoid using this strategy in a trending market where the movements are unpredictable.
Of course no one can judge the market completely at any point of time. So it is more important to reduce your risk on any strategy than chasing the profit.
Hope this article helped you to learn another option trading strategy. Happy reading ..