Hey everyone. This is Kirk, here again at optionalpha.com,
and this is the video tutorial for the short straddle option strategy. As we get into it here, the market outlook
for this strategy as a trader is that you're looking for a completely flat stock and virtually
no movement at all. And I mean, literally no movement. You want a stock that is trading absolutely
flat, very little intraday and daily movement. This market neutral strategy is really designed
for low volatility conditions where stocks are inactive and you can collect a premium
as a result. So, that's the only strategy that I would
use this particular short straddle on going forward. Now, how to set up a short straddle is actually
pretty easy. You're going to basically think about it like
selling two options individually. You're just going to put them together. So, you're simply going to sell a call option
and a put option with the same strike price for the same expiration period. So in our example here, what we're going to
do is sell one at the money call at a strike price of 40, and we're also going to sell
another at the money put at a strike price of 40. And that creates the point here where the
option payoff diagram pivots. Now, to learn more about option payoff diagrams,
just watch one of our other video tutorials. Now, you can shift your sales up or down. But most strategies are centered at the money. Like you can shift these strategies to the
right or to the left, you can shift them up towards 50 or down towards 30. But really, if you want the stock to trade
virtually flat or no movement at all, you're going to center it right around where the
stock is trading right now. That's going to be your biggest area of profit
potential. So, what's the risk? Well, the risk of this strategy is that the
stock actually moves outside of your boundary or breakeven point. And there is a maximum loss probability here
or unlimited potential with this strategy because the stock can go up exponentially
in price. If that happens, then you could see really,
really big losses. Of course, you can mitigate this loss with
some of the premium that you received and hedging strategy that I'm going to talk about
here at the end of this video. The profit potential for this strategy is
pretty limited. The maximum gain you can get is just the income
you receive from selling both options. So again, remember that we're going to take
income in right off the bat, and we want to keep as much of that income as possible. We can't get any more income. You can see it's 100% capped at $400. You can't get more than that on this particular
strategy. So, since we're selling options with the same
strike price using at the money options, you stand to make good income should the stocks
stay flat. As we talked about earlier, you don't want
any volatility movement in this particular strategy. Remember that volatility is very, very bad. You want no volatility. You want the stock to trade basically flat
or even. So, any increases in implied volatility could
actually create a loss, even if the stock doesn't move. If generally, options are more volatile and
your stock still doesn't move, then even that one factor of implied volatility can create
a small loss for your strategy. Time decay is actually really positive for
this particular option strategy. So, since we are selling options and taking
in that premium right off the bat, the best thing that can happen is that these options
can expire worthless. So, each day that the stock doesn't move or
move slightly, creates the opportunity for making money. So, remember that time decay for this strategy
means profits. And usually, time decay for any option selling
strategy means more profit and more income. Now, breakeven points are very easy to calculate. It's very similar to how we calculated them
with long straddles as well. But with short straddle, what you're going
to do for the upper-level breakeven point is you're going to take the short call value
and you're going to add the premium that you received. And that's going to give you this particular
point here on the graph which is where it breaks even on the upper-level. For the lower level, you're going to take
the short put strike and you're going to subtract the premium that you received as well. And again, that creates this other lower-level
breakeven point. So, as long as the stock closes inside this
range, centered around 40, you're going to make money at expiration. Now, let's look at an example here. Let's again, say the stock is trading at a
price of around $40, right here where my cursor is. So, you're going to sell one 40 call for $200,
and then you're going to sell a 40 put for $200 as well, taking in a total of $400 on
the trade combined. Now, your maximum loss again, is unlimited
because the stock can continue to rise or continue to fall. We want it to stay very, very neutral to flat. The maximum profit you can make on this strategy
is $400. And that is the credit that you received for
selling these options. You can't make any more than that. And notice on my chart here how the profit
loss diagram is capped at $400. So, some tips and tricks that I've learned
over the years that I want to share with you guys. Many months of consistent profits with this
strategy can be quickly erased without proper risk management. Really, I guess that could be used in any
trading strategy that you have. But this in particular - I've seen a lot of
traders who have used this very consistently over a couple of months. They'd make a couple of hundred dollars and
they wipe it out during periods of high volatility. So, you want to use these during periods of
high to low volatility versus adding during periods of already low volatility. If you add during periods of low volatility,
then you run the risk of increasing volatility that the stock has a breakout. What you'd ideally like to do is capture the
stock after it's already made a dramatic move and is starting to settle down. Now, you can easily hedge this position by
purchasing another call or put and creating a credit spread on either end. So, I'm going to show you what this means
with my cursor. Let's say that the stock is starting to move
outside of the 40 mark. You can easily purchase a call option right
here at a strike price of 50 and it would cap your losses at the 50 strike price. Same thing if the stock was starting to move
down dramatically. You could easily purchase a put option with
a strike price of 30, and that would cap your losses to the downside at 30. So again, this is something you can do later
on down the road as you start to adjust and watch this position evolve. You don't have to do it right now or as soon
as you enter this position, but you should have it at least, in the back of your mind
here as a way to hedge and protect the unlimited risk feature of this strategy. So as always, I hope you guys really enjoyed
this video. And thanks for watching. Please use the social links right below here
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