Short straddles are essentially the opposite of long straddles. In the previous chapter, we learned that long straddles can profit when the market is volatile. Conversely, short straddles can profit when the market is flat (neutral).
These are the components of a short straddle:
Short call & short put*
*Must be the same strike price and expiration
For example:
Short 1 ABC Jan 60 call
Short 1 ABC Jan 60 put
As you already know, a short call creates an obligation to sell, while a short put creates an obligation to buy.
By selling both options, the investor is betting on market neutrality.
If the stock’s market price stays flat, both options may expire worthless. This happens when ABC’s market price is exactly the shared strike price, which is the best-case scenario for a short straddle.
If the stock’s market price rises, the investor’s call will be assigned (exercised). This is the highest-risk direction because the call obligates the investor to sell shares at the strike price. To deliver shares, the investor must first buy them at the market price. The higher the market price rises, the more expensive it is to buy the shares, and the larger the loss.
If the stock’s market price falls, the investor’s put will be assigned (exercised). This also creates significant risk because the put obligates the investor to buy shares at the strike price. The further the market price falls, the more the investor overpays relative to market value, and the larger the loss.
A short straddle is a risky strategy because it involves two naked (uncovered) options. However, the investor receives two premiums up front. That means losses on either side must exceed the combined premiums before the position produces an overall loss. The investor is most likely to profit when the stock’s market price doesn’t move much.
Let’s walk through several scenarios to see how short straddles work.
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market rises to $120?
Can you figure it out?
Answer = $5,100 loss
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Buy shares | -$12,000 |
| Call assigned - sell shares | +$6,000 |
| Total | -$5,100 |
At $120, the call is in the money (has intrinsic value) and the put is out of the money (no intrinsic value). The put expires worthless, but the call is assigned (exercised), so the investor must fulfill the obligation to sell.
To do that, the investor buys the stock in the market at $120 and then sells it at $60. That’s a $60 loss per share, or $6,000 total ($60 × 100 shares). The $900 combined premium received up front reduces the loss to $5,100.
The investor wanted a flat market, but instead the stock rose sharply. Even though only one option went in the money, the short call created a large loss. The premiums offset part of that loss, but the overall result is still substantial.
The maximum loss for a short straddle is unlimited. As the market rises, losses can keep increasing because of the short naked call.
What happens if the market rises a moderate amount?
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market price rises to $69?
Answer = $0 (breakeven)
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Buy shares | -$6,900 |
| Call assigned - sell shares | +$6,000 |
| Total | $0 |
At $69, the call is in the money and the put is out of the money. The put expires worthless, but the call is assigned (exercised).
The investor buys the stock at $69 and sells it at $60, for a $9 loss per share, or $900 total ($9 × 100 shares). The $900 combined premium received up front offsets that loss, so the result is breakeven.
$69 is one of two breakevens in this example (we’ll find the other one later). On the upside, the short straddle breaks even when the loss on the short call equals the combined premiums. That’s why the upside breakeven is:
What happens if the market rises slightly?
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market price rises to $64?
Answer = $500 gain
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Buy shares | -$6,400 |
| Call assigned - sell shares | +$6,000 |
| Total | +$500 |
At $64, the call is in the money and the put is out of the money. The put expires worthless, and the call is assigned (exercised).
The investor buys the stock at $64 and sells it at $60, for a $4 loss per share, or $400 total ($4 × 100 shares). The $900 combined premium received up front more than offsets that loss, leaving a $500 gain.
This is the outcome a short straddle investor is hoping for: the stock moves, but not enough for the intrinsic value on the in-the-money option to exceed the combined premiums.
What happens if the market remains flat?
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market price stays at $60?
Answer = $900 gain
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Total | +$900 |
At $60, both options are at the money, so each expires worthless (contracts must have intrinsic value to be exercised). The investor keeps the entire $900 in combined premiums.
This is the best-case scenario because it produces the maximum gain.
The maximum gain for a short put can be found by using this formula:
What happens if the market falls a small amount?
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market price falls to $59?
Answer = $800 gain
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Put assigned - buy shares | -$6,000 |
| Share value | +$5,900 |
| Total | +$800 |
At $59, the put is in the money and the call is out of the money. The call expires worthless, but the put is assigned (exercised).
The investor buys shares at $60 that are worth $59, creating a $1 loss per share, or $100 total ($1 × 100 shares). The $900 combined premium received up front offsets that loss, leaving an $800 gain.
Again, the key idea is that small moves can still be profitable as long as the intrinsic value on the in-the-money option doesn’t exceed the combined premiums.
What happens if the market falls a little further?
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market price falls to $51?
Answer = $0 (breakeven)
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Put assigned - buy shares | -$6,000 |
| Share value | +$5,100 |
| Total | $0 |
At $51, the put is in the money and the call is out of the money. The call expires worthless, but the put is assigned (exercised).
The investor buys shares at $60 that are worth $51, creating a $9 loss per share, or $900 total ($9 × 100 shares). The $900 combined premium received up front offsets that loss, resulting in breakeven.
$51 is the other breakeven in this example. On the downside, the short straddle breaks even when the loss from the short put equals the combined premiums. That’s why the downside breakeven is:
Here’s the general formula for breakeven on straddles:
The breakeven formula is the same for both long and short straddles.
Straddles are one of the only options strategies with multiple breakevens. To find both quickly:
In summary, the two breakevens for this long straddle are $51 and $69.
What happens if the market falls significantly?
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. What is the gain or loss if ABC’s market price falls to $25?
Answer = $2,600 loss
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Put assigned - buy shares | -$6,000 |
| Share value | +$2,500 |
| Total | -$2,600 |
At $25, the put is in the money and the call is out of the money. The call expires worthless, but the put is assigned (exercised).
The investor buys shares at $60 that are worth $25, creating a $35 loss per share, or $3,500 total ($35 × 100 shares). The $900 combined premium received up front reduces the loss to $2,600.
The investor wanted a flat market, but instead the stock fell sharply. Even though only one option went in the money, the short put created a large loss. The premiums offset part of that loss, but the overall result is still substantial.
Let’s look at the options payoff chart to summarize the big picture for this short straddle. First, here’s the example again:
Short 1 ABC Jan 60 call @ $4
Short 1 ABC Jan 60 put @ $5
Here’s the payoff chart:
The horizontal axis represents the market price of ABC stock, while the vertical axis represents overall gain or loss.
As the short straddle payoff chart shows, the investor reaches their maximum gain of $900 at a market price of $60. At that point, both options expire worthless, and the combined premiums are the overall gain.
If the market price rises above or falls below $60, either the call or the put goes in the money and gains intrinsic value. Remember, option writers (sellers) lose when their contracts gain intrinsic value. Intrinsic value benefits the holder (buyer, long side) and hurts the writer (seller, short side).
In the last few examples, we’ll look at what happens when the investor closes out contracts at intrinsic value. As we’ve learned previously, closing out contracts means trading the contracts instead of waiting for assignment or expiration.
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. ABC’s market price falls to $40 and the investor closes the contracts at intrinsic value. What is the gain or loss?
Answer = $1,100 loss
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Close call | $0 |
| Close put | -$2,000 |
| Total | -$1,100 |
At $40, the put is in the money and the call is out of the money.
The investor received $9 in premium up front but pays $20 to close the put, which is an $11 per share loss, or $1,100 total ($11 × 100 shares).
As a reminder, closing a position means doing the opposite of the opening transaction. Here, the investor sold two options to open the short straddle (opening sales), so they must buy both options to close (closing purchases). After selling $900 of options and buying to close for $2,000, the investor has a $1,100 loss.
Let’s examine one more closing-transaction scenario.
An investor goes short 1 ABC Jan 60 call at $4 and short 1 ABC Jan 60 put at $5 when ABC’s market price is $60. ABC’s market price rises to $67 and the investor closes the contracts at intrinsic value. What is the gain or loss?
Answer = $200 gain
| Action | Result |
|---|---|
| Sell call | +$400 |
| Sell put | +$500 |
| Close call | -$700 |
| Close put | $0 |
| Total | +$200 |
At $67, the call is in the money and the put is out of the money.
The investor received $9 in premium up front and pays $7 to close the call, which is a $2 per share gain, or $200 total ($2 × 100 shares).
As in the previous example, the investor opened with two opening sales and closes with two closing purchases. After selling $900 of options and buying to close for $700, the investor has a $200 gain.
This video covers the important concepts related to short straddles:
For suitability, short straddles should only be recommended to aggressive options traders with a substantial net worth when a flat market is expected. If there is unexpected volatility, the investor is subject to unlimited risk. The fewer assets or money an investor has, the less likely they should be selling straddles.
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