Short straddle
Also written Sell straddle · Short straddle strategy
Selling a call and a put with the same strike and same expiry, betting the underlying stays still. Profit is capped at the two premiums; losses grow without limit on a big move either way.
In plain language
A short straddle is a bet on nothing much happening.
The trader sells a call and a put at the same strike and collects both premiums. If the underlying finishes near that strike, both options are worth little or nothing and the trader keeps most of the premium.
If the underlying moves a long way, in either direction, one of the two sold options becomes expensive to settle, and the loss keeps growing the further the price travels. The workbook calls it "a limited profit and unlimited loss strategy" that "should be undertaken with significant care".
How it works
Construction (Chapter 17): a short straddle is created by shorting a call and a put option of the same strike and same expiry date. It is the exact opposite of a long straddle, so its pay-off chart is the long straddle's chart turned upside down.
Outlook: the price of the underlying would not move much or would remain stable. In the interest rate chapter (Chapter 22) the same view is expressed as not much movement in interest rates or bond yields.
The workbook's numbers: stock at Rs 6,000; ATM call premium Rs 257, ATM put premium Rs 136.
- Maximum profit = 257 + 136 = Rs 393, earned if the stock expires exactly at 6,000.
- Break-evens = Strike ± total premium = 6,000 − 393 = 5,607 and 6,000 + 393 = 6,393.
- Between 5,607 and 6,393 the position is profitable; outside that band it loses, and the loss is unlimited as the price moves further.
The butterfly spread is described as an extension of the short straddle: buying an OTM call and an OTM put alongside it limits that unlimited downside.
The formula
Premium collected = Call premium + Put premium
Pay-off at expiry = Premium collected − |S − X|
Maximum profit = Premium collected (at S = X)
Upper break-even = X + Premium collected
Lower break-even = X − Premium collected
Maximum loss = unlimited
A worked example
The workbook's Chapter 17 short straddle: strike 6,000, call premium 257, put premium 136, premium collected 393.
| Stock at expiry | Short call | Short put | Net |
|---|---|---|---|
| 5,300 | +257 | 136 − 700 = −564 | −307 |
| 5,600 | +257 | 136 − 400 = −264 | −7 |
| 5,800 | +257 | 136 − 200 = −64 | +193 |
| 6,000 | +257 | +136 | +393 |
| 6,300 | 257 − 300 = −43 | +136 | +93 |
| 6,400 | 257 − 400 = −143 | +136 | −7 |
| 6,700 | 257 − 700 = −443 | +136 | −307 |
The net at 5,600 and 6,400 is −7, which is exactly the distance past the break-evens of 5,607 and 6,393.
Illustrative scaling: with a lot of 100 shares (an assumed lot size), the best case is 393 × 100 = Rs 39,300. A move to 6,700 costs 307 × 100 = Rs 30,700, and a move to 7,000 costs 607 × 100 = Rs 60,700, already more than the best case, with no ceiling beyond it.
Why NISM asks about it
Chapter 17 (Strategies using Equity Futures and Equity Options) sets out the long and short straddle with the Rs 6,000 stock and its pay-off tables; Chapter 22 (Strategies using Interest Rate Derivatives) repeats the short straddle on a government security at a strike of Rs 99. Expect a break-even calculation, a maximum-profit question, and a question on which view suits the strategy (a range-bound market).
Common exam traps
- Same strike, same expiry, one call and one put, both sold. Different strikes make it a strangle.
- Limited profit, unlimited loss. The long straddle is the reverse.
- Two break-evens: strike ± total premium. Not strike ± one premium.
- The view is low volatility, not a directional view. A trader expecting a big move buys the straddle instead.
- A short straddle is not a hedge. Both legs are sold and nothing in the position offsets a large move; it is a view on stability.
- The butterfly spread is the short straddle with its tails bought back, which caps the loss.
Where this is taught
- Series IV · Chapter 5: Strategies using Interest Rate Derivativesintroduced here
- Series VIII · Chapter 5: Strategies using Equity Futures and Equity Optionsintroduced here
- Series V-D · Chapter 17: Strategies using Equity Futures and Equity Optionsintroduced here
- Series V-D · Chapter 22: Strategies using Interest Rate Derivatives
Related terms
- Break-even pointThe level of the underlying at which a position makes neither profit nor loss — for a bought call, strike plus premium; for a bought put, strike minus premium.
- Butterfly spreadA four-legged position — one option bought at a low strike, two sold at a middle strike and one bought at a high strike, all of the same expiry — that caps the unlimited loss of a short straddle.
- Implied volatilityThe volatility figure that, put into an option pricing model, reproduces the option's actual market price — the market's consensus forecast of how much the underlying will move.
- Long straddleBuying a call and a put at the same strike and the same expiry — a bet that the underlying moves a long way in either direction, with two break-even points and a maximum loss equal to both premiums.
- Option writerThe party who sells an option: receives the premium upfront and takes on the obligation to sell (call) or buy (put) the underlying if the buyer exercises. Gain is capped at the premium.
- Short strangleSelling an out-of-the-money call and an out-of-the-money put on the same underlying and expiry. It profits if the price stays between the two strikes; losses are unlimited on a large move.
- Time decayThe steady loss of an option's time value as expiry approaches — the reason options are called wasting assets and the reason the workbook says option sellers hold a structural advantage.
- ThetaThe option Greek that measures time decay — the change in an option's premium for a one-day decrease in time to expiry. It is negative for a long option, call or put alike.
- Long strangleBuying an out-of-the-money call and an out-of-the-money put with the same expiry but different strikes — the cheaper cousin of the straddle, with a wider band of loss between two break-even points.