A short straddle is a position that is a neutral strategy that profits from the passage of time and any decreases in implied volatility.

Before that, let’s duel with the concept of ATM options. Right now NIFTY 50 Spot price is 9920. What do you call as ATM option if NIFTY 50 spot price is at 9925?

9925 CE or 9925 PE doesn’t exist. What exists nearby is 9900 CE/PE and 9950 CE/PE. Theoretically, none are ATM options. 9950 CE/PE are same as far as 9900 CE/PE from 9925.

Theoretically, ATM is 9925 CE, 9925 PE if the spot is 9925.

When to do straddle?

  • For BankNIFTY options – the day before the expiry of that option ~ each Wednesday.
  • For NIFTY options and stock options – the last Thursday preceding the expiry week.

What to avoid?

Company Returns, Corporate Announcements, Board Meetings – Companies having any kind of strong fundamental news. But technicals take the lead. Fundamentals can be ignored.

For NIFTY we get around 200 points to hover around for profits and a straddle gives a sound range of 200 points. Let’s see the hourly chart first.

short straddle option strategy

Right now we are slightly bearish on NIFTY. So what is the theoretical setup here-

Setup:

  •  Sell ATM Call
  •  Sell ATM Put

Q. But why not selling naked 9900 CE as market falling chance is more as per the charts?

A. In these two conditions

  •  Nifty will stay below 9900.
  • Nifty will stay below 9999 and above 9801

Which one has more profit of probability?

Now as discussed, the setup is

  •  Sell ATM Call
  • Sell ATM Put

Unless you have algorithms to execute it when the NIFTY spot is perfectly 9900 you can not catch it perfectly. So You have three options here

Sell 9850 CE, Sell 9850 PE. You will stay in profit if NIFTY stays between 9750 and 9950. Maximum profit is 9210 on 98235 employed.  Sell 9900 CE, Sell 9900 PE

sell straddle

Maximum profit is 8175 on 97425 employed. You will stay in profit if NIFTY stays between 9801 and 9999.

short straddle example

Sell 9950 CE, Sell 9950 PE. You will stay in profit if NIFTY stays between 9850 and 10050. Maximum profit is 8002 on 97477 employed.

Now you have three options-

  • You will stay in profit if NIFTY stays between 9750 and 9950.
  • You will stay in profit if NIFTY stays between 9801 and 9999.
  • You will stay in profit if NIFTY stays between 9850 and 10050.

See the charts and take the decision.

sell straddle

Q. How to choose which one is most profitable?

A. Which one is more profitable comes late. Which one has more success of winning comes first. More profitability question comes later after winning.

Here goes the daily chart of NIFTY –

short straddle option strategy

Every trader will have their own personal view. Right now I am betting NIFTY is facing a resistance there. Then I zoomed into an hourly chart.

short straddle strategy

I chose hence the second. A straddle is a technique which you have been taught. Now the choice of those three options and their rationality will depend on your application of knowledge over technicals which will differ.

Q. What about option 1, the probability of that happening is more if we consider FA (Fundamental Analysis) also?

A. You can not predict NIFTY with FA. When demonetization happened all fundamentalist threw buy call saying it is good for long term. NIFTY got demonetized for a month after that. Retailers can not afford that amount of huge unrealized loss.

Q. What is the stop loss here?

A. No; there is no concept of stop loss here. You just close the trade when you see it doesn’t satisfy the underlying concept. Also, with short straddles, we don’t have much wiggle room because the short options are already on the same strikes.

Sell 9900 CE, Sell 9900 PE. Maximum profit is 8175 on 97425 employed.

You will stay in profit if NIFTY stays between 9801 and 9999. If you see in hourly chart NIFTY is breaking this range. You book it. Anyways your chance of staying in profit is high because – Theta decay is at highest on last week of options (as we are talking about NIFTY)

Q. When do we close straddles?

A. The first profit target is generally 25% of the maximum profit. Or use it as trailing stop loss.

Q. How to calculate the break-even points –

A.  Downside: Subtract initial credit from Put strike price.  Upside: Add the initial credit to the Call strike price.

  • Initial credit – 44.45 + 60.50 = 104.95
  •  Downside: 9900 -104.95 = 9795.05
  •  Upside: 9900 + 104.95 = 10004.95

The spread of 104.95 between downside and upside will keep decreasing each day because value of both 9900 CE/PE will tend to decrease due to theta decay.

Every trade has a certain risk. We are betting on a range here instead of a naked statement.

The sum here is 60.50 + 44.45 = 104.95 which is your highest profit right? Your task here is to get more points from 104.95 Suppose you have taken this position since we are discussing this –

See now the maximum profit is decreased to 57.75+46.5 = 104.25. See this decrease of 104.95 – 104.25 = .7 is due to theta decay! That’s where our eyes are.

Q. But, can we draw a line like this?

A. Yes. That’s how you differ with me. Multiple views and perspectives are important in markets. But I see the channel is broken. Refer –

Profit on the capital employed is always high on naked selling of 9900 CE. But it is riskier than the combined setup of 9900 PE and 9900 CE. Whenever you try to decrease the risk; you need to pay the fees of doing it by the margin to let’s say. Otherwise, who won’t try the less risky option setup when the profitability is same.

If I sell KOTAKBANK17JUL990CE at 29.65 now.

  • KOTAKBANK17JUL990CE will become 0 if KOTAKBANK’s price is 990 by the time of expiry.
  • KOTAKBANK17JUL990CE will become 1 if KOTAKBANK’s price is 991 by the time of expiry.
  • KOTAKBANK17JUL990CE will become 2 if KOTAKBANK’s price is 992 by the time of expiry.

So to make me profit KOTAKBANK17JUL990CE should stay below or at 29.65 by the time of expiry.

So to make me profit KOTAKBANK should stay below or at 29.65 990+29.65 = 1019.65 by the time of expiry.

If I sell NIFTY17JUL9900PE at 46.15 now.

  • NIFTY17JUL9900PE will become 0 if NIFTY’S price is 9900 by the time of expiry.
  • NIFTY17JUL9900PE will become 1 if NIFTY’S price is 9899 by the time of expiry.
  • NIFTY17JUL9900PE will become 2 if NIFTY’S price is 9898 by the time of expiry.

So to make me profit NIFTY17JUL9900PE should stay below or at 46.15 by the time of expiry.

If you see this BankNIFTY 20th July 24200 CE at 54.1 you can not make the loss unless NIFTY BANK goes above 24254.1.

If you are bearish on bank nifty will you short Bank NIFTY futures or BankNIFTY 20th July 24200 CE?

Well, you should wait for price action first. If it crosses there it will go upside in a spike. Now it is a resistance but wait for candle completion.-

Resistance is broken.

Q. So better to go with 24300 CE?

A. No, not yet. Wait for candle completion.

Q. Should we wait till it forms any red? Or this was the candle you were expecting to be turned red?

A. Well, Bull trend is the bull trend. When you told me 24300 CE was at 19; now it is at 22. You saved 120 INR per lot. Wait for confirmation always.

With straddles, it is important to remember that we are working with truly undefined risk in selling a naked call. We focus on probabilities at trade entry and make sure to keep our risk/reward relationship at a reasonable level.

Implied volatility (IV) plays a huge role in our strike selection with straddles. The higher the IV, the more credit we will receive from selling the options. A higher credit ultimately means we will have wider breakeven points since we can use the credit to offset losses we may see to the upside or downside. At the end of the day, a larger relative credit results in a higher probability of success with this strategy.

When there is an event that is likely to impact the price of an equity (e.g., earnings; RBI ruling; new product release; etc.,) you will see an increase in the option pricing. This rise in pricing is attributed to an increase in the option’s implied volatility. When the implied volatility is high, that means that the market anticipates a greater movement in the stock price.

Right now Axis Bank’s results are near; so the implied volatility is high on its options.