Short Straddle

SELL 1 EXXON JUNE 70 CALL @ 4 SELL 1 EXXON JUNE 70 PUT @ 3

OUTLOOK-NEUTRAL S - STRIKE PRICE - $70 LBEP - LOWER BREAK EVEN POINT - $63 HBEP = HIGHER BREAK-EVEN POINT - $77 CR= CREDIT = MAXIMUM GAIN = $700

Example

Market price of Exxon stock: $70

In this example, the trader has initiated a short combination since the security and the expiration months are the same, but the strike prices are different. The advantage of this short combination is that the strike prices are spaced further apart, creating a larger window for gains; however, because of the widened strike prices, the premiums that the seller receives will be lower than those for short straddles. Here, the trader has sold one Exxon call option with a June expiration and a $75 strike price for $300 and has sold one Exxon put option with a June expiration and a $65 strike price for $250, when Exxon is trading at $70 per share. Therefore, the total premium received by the option writer on the combination is $550. This is a nonrefundable, fixed income payment to the trader and cannot be lost. This $550 is also the most the trader can make on the transaction—if both the call and the put option were to expire at-the-money or out-of-the-money, meaning Exxon stock were trading at $65 per share, $75 per share, or somewhere in between, the trader would owe nothing and keep the $300 on the short June 75 call and the $250 on the short June 65 put. Again, the trader would ideally like to see the market move sideways. If Exxon stock were trading at $80 per share, the trader would lose $500 on the short June 75 call option position that is in-the-money, lose nothing on the short June 65 put option position that is out-of-the-money, and make $550 on the fixed cost to initiate the combination, for a net gain of $50. If Exxon were trading at $60 per share, the trader would lose nothing on the short June 75 call option position that is out-of-the-money, lose $500 on the short June 65 put option position that is in-the-money, and make $550 for the fixed cost to initiate the combination, for a net gain of $50. If Exxon stock were trading at $8054 per share, the trader would lose $550 on the short June 75 call option position that is in-the-money, lose nothing on the short June 65 put option position that is out-of-the-money, and make $550 in nonrefundable costs to initiate the combination, for a net gain of zero. If Exxon stock were trading at $59J4 per share, the trader would lose nothing on the short June 75 call option position that is out-of-the-money, lose $550 on the short June 65 put option position that is in-the-money, and make $550 in nonrefundable costs to initiate the combination, for a net gain of zero. If Exxon stock were trading at $85 per share, the trader would lose $1000 on the short June 75 call option position that is in-the-money, lose nothing on the short June 65 put option position that is out-of-the-money, and make $550 in fixed costs necessary to initiate the combination, for a net loss of $450. Finally, if Exxon stock were trading at $55 per share, the trader would lose nothing on the short June 75 call option position that is out-of-the-money, lose $1000 on the short June 65 put option position that is in-the-money, and

PAYOFF DIAGRAM 2.12 Profit diagrams for a short combination and the Exxon short combination example.

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