What Is a Covered Straddle?
A covered straddle is a option strategy that tries to profit from bullish price developments by composing puts and calls on a stock that is likewise owned by the investor. In a covered straddle the investor is short on an equivalent number of both call and put options which have a similar strike price and expiration.
How Covered Straddles Work
A covered straddle is a strategy that can be utilized to profit for bullish price expectations on an underlying security possibly. Covered straddles can typically be handily developed on stocks trading with high volume. A covered straddle likewise includes standard call and put options which trade on public market exchanges and works by selling a call and a put in a similar strike while claiming the underlying asset. In effect it is a short straddle while long the underlying.
Like a covered call, where an investor sells upside calls while possessing the underlying asset, in the covered straddle the investor will at the same time sell an equivalent number of puts at a similar strike. The covered straddle, since it has a short put, in any case, isn't completely covered and can lose huge money in the event that the price of the underlying asset drops fundamentally.
Illustration of Covered Straddle Construction
As in any covered strategy, the covered straddle strategy includes the ownership of an underlying security for which options are being traded. In this case, the strategy is just somewhat covered.
Since most option contracts trade in 100 share parcels, the investor typically needs to have no less than 100 shares of the underlying security to start this strategy. At times, they may currently claim the shares. In the event that the shares are not owned the investor buys them in the open market. Investors could have 200 shares for a completely covered strategy, however it isn't expected that the two contracts be in the money simultaneously.
Step one: Own 100 shares with an at the money value of $100 per share.
To build the straddle the investor composes the two calls and puts with at the money strike prices and a similar expiration. This strategy will have a net credit since it includes two initial short sales.
Step two: Sell XYZ 100 call at $3.25 Sell XYZ 100 put at $3.15
The net credit is $6.40. In the event that the stock takes no action, the credit will be $6.40. For each $1 gain from the strike the call position has a - $1 loss and the put position gains $1 which equals $0. Subsequently, the strategy has a maximum profit of $6.40.
This position has high risk of loss on the off chance that the stock price falls. For each $1 decline, the put position and call position each have a loss of $1 for a total loss of $2. Consequently, the strategy starts to have a net loss when the price comes to $100 - ($6.40/2) = $96.80.
Covered Straddle Considerations
The covered straddle strategy isn't a completely "covered" one, since just the call option position is covered. The short put position is "bare", or uncovered, and that means that whenever assigned, it would require the option writer to buy the stock at the strike price to complete the transaction. Nonetheless, it isn't probable that the two positions would be assigned.
While gains with the covered straddle strategy are limited, large losses can result in the event that the underlying stock tumbles to levels well below the strike price at option expiration. In the event that the stock doesn't move a lot of between the date that the positions are placed and expiration, the investor gathers the premiums and understands a small gain.
Institutional and retail investors can build covered call strategies to search out possible profits from option contracts. Any investor seeking to trade in derivatives should have the vital consents through a margin trading, options platform.
- Like a covered call, the covered straddle is planned by investors who accept the underlying price won't move particularly before expiration.
- A covered straddle is an options strategy including a short straddle (selling a call and put in a similar strike) while claiming the underlying asset.
- The covered straddle strategy isn't a completely "covered" one, since just the call option position is covered.