29 lines
2.0 KiB
Plaintext
29 lines
2.0 KiB
Plaintext
Trading the Short Straddle
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A short straddle is a trade for highly speculative traders who think a security
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will trade within a defined range and that implied volatility is too high.
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While a long straddle needs to be actively traded, a short straddle needs to
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be actively monitored to guard against negative gamma. As adverse deltas
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get bigger because of stock price movement, traders have to be on alert,
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ready to neutralize directional risk by offsetting the delta with stock or by
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legging out of the options. To be sure, with a short straddle, every stock
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trade locks in a loss with the intent of stemming future losses. The ideal
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situation is that the straddle is held until expiration and expires with the
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underlying right at $70 with no negative-gamma scalping.
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Short-straddle traders must take a longer-term view of their positions than
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long-straddle traders. Often with short straddles, it is ultimately time that
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provides the payout. While long straddle traders would be inclined to watch
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gamma and theta very closely to see how much movement is required to
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cover each day’s erosion, short straddlers are more inclined to focus on the
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at-expiration diagram so as not to lose sight of the end game.
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There are some situations that are exceptions to this long-term focus. For
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example, when implied volatility gets to be extremely high for a particular
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option class relative to both the underlying stock’s volatility and the
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historical implied volatility, one may want to sell a straddle to profit from a
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fall in IV. This can lead to leveraged short-term profits if implied volatility
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does, indeed, decline.
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Because of the fact that there are two short options involved, these
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straddles administer a concentrated dose of negative vega. For those willing
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to bet big on a decline in implied volatility, a short straddle is an eager
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croupier. These trades are delta neutral and double the vega of a single-leg
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trade. But they’re double the gamma, too. As with the long straddle,
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realized and implied volatility levels are both important to watch. |