14. Short Straddle
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Scenario:
This trader finds a market with relatively high implied volatility. The current feeling is the market will stabilize after having had a long run to its present level. To take advantage of time decay and dropping volatility this trader sells both a call and a put at the same strike price.
Specifics:
| Underlying Futures Contract: | September Japanese Yen | |
| Futures Price Level: | 0.8600 | |
| Days to Futures Expiration: | 40 | |
| Days to Options Expiration: | 30 | |
| Option Implied Volatility: | 12.6% | |
| Option Position: | Short 1 Sep 0.8600 Call | + 0.0100 ($1250.00) |
| Short 1 Sep 0.8600 Put | + 0.0100 ($1250.00) | |
| + 0.0200 ($2500.00) |
At Expiration:
| Breakeven: | Downside: 0.8400 (0.8600 strike - 0.0200 credit). Upside: 0.8800 (0.8600 strike + 0.0200 credit). |
| Loss Risk: | Unlimited; losses increase as futures fall below 0.8400 breakeven or rise above 0.8800 breakeven. |
| Potential Gain: | Limited to credit received; maximum profit of 0.0200 ($2500) achieved as position is held to expiration and futures close exactly 0.8600 strike. |
Things to Watch:
This is primarily a volatility play. A trader enters into this position with no clear idea of market direction but a forecast of less movement (risk) in the underlying futures. Be aware of early exercise. Assignment of a futures position transforms this strategy into a synthetic short call or synthetic short put.
Follow-up Trading Strategies
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Options Risk Disclosure: An option on a commodity futures contract is a right, purchased for a certain price, to either buy or sell a commodity futures contract during a certain period of time for a fixed price. Although successful commodity options trading requires many of the same skills as does successful commodity futures trading, the risks involved are somewhat different. For example, if a customer buys an option (either to sell or purchase a futures contract or commodity), the customer will pay a “premium” representing the market value of the option. Unless the price of the futures contract underlying the options changes and it becomes profitable to exercise or offset the option before it expires, the customer’s account may lose the entire amount of such premium (together with the costs of commissions and fees incurred to purchase such options). Conversely, if a customer sells an option (either to sell or purchase a futures contract or commodity), the customer will be credited with the premium but will have to deposit margin due to its contingent liability to take or deliver the futures contract underlying the option in the event the option is exercised. The writer of the option is however at unlimited risk with respect to the call option written, and risk on the put option of the amount should the price of the futures contract drop to zero. Sellers of options are subject to the loss which occurs in the underlying futures position (less any premium received). The ability to trade in or exercise options may be restricted in the event that such trading on U.S. commodity exchanges is restricted by both the CFTC and such exchanges, and it has been at certain times in the past.
