Equity and Index Options Explained

21

Short Straddles

In an earlier chapter on the uses of options, the point was made that, due to their multifaceted nature, options give us more ways in which to trade than futures or physical. For example, suppose we believe that the underlying is going to stay exactly where it is for the next month or so. Can we use futures or physical to exploit this view? No, but we can use options to benefit enormously from such a scenario. Specifically, we can use short straddles or strangles.

What is a short straddle? A short straddle consists of two legs, a short call and a short put with the same strike and from the same series. Selling a straddle involves selling both options simultaneously. In practice, it tends to be at-the-money or close-to-the-money straddles that are sold, though this need not necessarily be the case. We will focus initially upon selling at-the-money straddles, as in the following example, before briefly considering how and why we might sell straddles away from the money.

From the matrix of Sep BP option prices (Table 21.1, repeated from Table 16.1), selling the 520 straddle consists of two legs, selling the 520 call at 28 and simultaneously selling the 520 put at 29. The price received for the straddle is 57 ticks (equivalent to £570) per straddle sold, the sum of the 28 received for the 520 call and the 29 received for the 520 put. These 57 ticks represent the maximum profit on selling the straddle. If BP is at exactly 520 (i.e. £5.20) on Sep expiry, then both ...