Strategies in Trading Options Contracts (Part 7)

Following up on our previous Q&A session, this issue of the Industry and Trade Newspaper will continue to introduce another strategy to help investors optimize profits when the market price of the underlying asset is unlikely to fluctuate much. This is strategy number 7 - the Short Straddle strategy.

Short Straddle Strategy

The Short Straddle strategy involves simultaneously selling both a call option and a put option on an underlying asset with the same strike price and expiration date. This strategy has a limited profit potential and an unlimited loss potential, depending on the volatility of the underlying asset's market price. Therefore, it is a high-risk strategy.

Strategies in Options Trading (Part 7). Image MXV

At the expiration date, if the price of the underlying asset does not differ significantly from the option's strike price, the investor will make a good profit. Conversely, if the difference is substantial, the investor is likely to suffer a large loss. The Short Straddle strategy is often used when investors believe that the market price of the underlying asset will fluctuate little compared to the option's strike price.

For example, an investor implements a Short Straddle strategy by simultaneously selling a call option on a December 2024 wheat contract with a strike price of 720 cents/bushel and an option premium of 64 cents/bushel, and selling a put option with a strike price of 720 cents/bushel and an option premium of 60 cents/bushel.

Profits from a Short Straddle strategy depend on the future price of the December 2024 Wheat futures contract (ZWAZ24). The following scenarios are possible:

Case 1: The ZWAZ24 contract price is higher than 720 cents/bushel.

If the price of the ZWAZ24 contract is higher than 720 cents/bushel, let's say 790 cents/bushel, the call option will be exercised. At this point, the investor must buy one ZWAZ24 contract at 790 cents/bushel to fulfill the obligation to sell this contract at 720 cents/bushel. Thus, the investor receives a profit of (64 + 60) - (790 – 720) = 54 cents/bushel.

Case 2: The ZWAZ24 contract price is exactly 720 cents/bushel.

The investor did not exercise any options. The investor received a profit equal to the total premium of the two options, which is (64 + 60) = 124 cents/bushel.

Case 3: The ZWAZ24 contract price falls below 720 cents/bushel.

If the price of the ZWAZ24 contract is lower than 720 cents/bushel, let's say 550 cents/bushel, the put option will exercise. At this point, the investor must fulfill the obligation to buy one ZWAZ24 contract at 720 cents/bushel and sell it at 550 cents/bushel. Thus, the investor incurs a loss of (720 – 550) - (64 + 60) = 46 cents/bushel.

Therefore, the Short Straddle strategy is a risky strategy as it limits the investor's profit to a certain level but exposes them to unlimited losses.

Source: https://congthuong.vn/hoi-dap-giao-dich-hang-hoa-so-72-cac-chien-luoc-trong-giao-dich-hop-dong-quyen-chon-phan-7-345156.html