A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted when the investor feels the market will not show much movement. He sells a Call and a Put on the same stock/index for the same maturity and strike price. It creates a net income for the investor.
The strategy works well if the the stock/index does not move much in either direction. In that case, the investor retains the Premium as neither the Call nor the Put will be exercised. However, if the stock/index moves in either direction, up or down significantly, the investor’s losses can be significant.
So, this is a risky strategy and should be carefully adopted and only when the expected volatility in the market is limited. If the stock/index value stays close to the strike price on expiry of the contracts, maximum gain, which is the Premium received is made.
When to Use: The investor thinks that the underlying stock/index will experience very little volatility in the near term.
Reward: Limited to the premium received
—Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
—Lower Breakeven Point= Strike Price of Short Put —Net Premium Received
Suppose Nifty is at 4450 on 27th April. An investor, Mr. A, enters into a short straddle by selling a May Rs. 4500 Nifty Put for Rs. 85 and a Mat Rs. 4500 Nifty Call for Rs. 122. The net credit received is Rs. 207, which is also his maximum possible profit.
Strategy: Sell Put+ Sell Call