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14.  Short Straddle

MENU - Futures Strategy Guide

Contents Courtesy of CME.com

short straddle

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

short straddle: follow-up trading strategies

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MENU - Futures Strategy Guide

Contents Courtesy of CME.com