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Execution Desk Specialist
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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