Bear Straddle
What Is a Bear Straddle?
A bear straddle is an options strategy that includes buying (or selling) both a put and a call on a similar underlying security with an indistinguishable expiration date and strike price, yet where the strike price is over the security's current market price.
This is a type of "slanted" or "slanted" straddle since the put will be in the money (ITM), which gives it a naturally bearish bias (for the long). A straddle traditionally utilizes the at-the-money (ATM) strike. A bull straddle, in comparison, would rather utilize a strike price below the market price.
Understanding a Bear Straddle
A straddle is an options strategy including the purchase (or sale) of both a put and a call option for a similar expiration date and strike price on the equivalent underlying. Dissimilar to a normal straddle, the strike price of a bear straddle is over the current price of the security, which gives a bearish lean to the position.
The put option of the bear straddle will accordingly be in the money (ITM) when the position is put on, while the call begins out of the money (OTM). The buyer of a bear straddle accepts that the underlying price will be unpredictable, with a greater inclination to drop, yet will likewise profit from a large increase. A writer of a bear straddle accepts that the price of the underlying asset will remain largely consistent to somewhat up during the life of the trade and that implied volatility (IV) will likewise stay consistent or decline.
When to Use a Bear Straddle
A trader would purchase a bear straddle in the event that they accept that the underlying security will face increased volatility, however are uncertain assuming the subsequent price moves will be to the upside or downside. With a bear straddle, the buyer would think that there is a greater likelihood the price will drop, yet might in any case profit from a critical up-move.
The maximum profit that can be created by a bear straddle seller is limited to the premium collected from the sale of the options. The maximum loss to the short, in theory, is unlimited. The ideal scenario for the writer is for the options to lapse worthless. The breakeven points (BEP) are defined by adding premiums received to the strike price to get the upside BEP and deducting premiums received from the strike price for the downside BEP.
A short bear straddle position profits provided that there is no movement in the price of the underlying asset. Notwithstanding, on the off chance that there is a broad movement either up or down, the short could face significant losses and be at risk of assignment. At the point when an options contract is assigned, the option writer must complete the requirements of the arrangement. On the off chance that the option were a call, the writer would need to sell the underlying security at the stated strike price. In the event that it were a put, the writer would need to buy the underlying security at the stated strike price.
The maximum profit that can be earned from a short bear straddle is the premium from the sale of the options; the maximum loss is possibly boundless. The maximum profit to the long is additionally unlimited, however makes all the more initially when the underlying falls.
At the point when Short Options Strategies Go Bad
Banks and securities firms sell bear straddles, along with other short options positions, to earn profits during times of low volatility. Be that as it may, the losses on these types of strategies can be boundless. Legitimate risk management is foremost. The story of Nick Leeson and the British merchant bank, Barings Bank, is a useful example of ill-advised risk management works on following the implementation of short straddle strategies.
Nick Leeson, the head supervisor of Barings trading business in Singapore, was entrusted with searching for arbitrage opportunities in Japanese futures contracts listed on the Osaka Securities Exchange and the Singapore International Monetary Exchange. All things being equal, Leeson made unhedged, directional wagers on the Japanese stock market. He immediately started losing money. To cover these losses, Leeson began selling bear straddles connected with the Nikkei. This trade was effectively betting that the stock index would trade inside a narrow band.
After a January 2018 seismic tremor struck Japan, the Nikkei sank in value. This Leeson trade and others cost the bank more than $1 billion and prompted the takeover of Barings bank by Dutch bank ING for \u00a31.
Features
- In a traditional straddle, the strike price utilized would be at the money.
- A bear straddle is a straddle that utilizes a strike higher than the current market price of the underlying security.
- This means that the put option will be in the money, giving it a natural bearish bias.
