Tag: Neutral

Iron Butterfly overview

The iron butterfly options strategy consists of selling an at-the-money short straddle and buying out-of-the-money options “on the wings” with the same expiration date to create a risk-defined position.

Iron butterfly trades look to take advantage of a drop in volatility, time decay, and little or no movement from the underlying asset.

Iron Butterfly market outlook

Iron butterflies are market neutral and have no directional bias. Iron butterflies capitalize on a decrease in volatility and minimal movement from the underlying stock to be profitable. A credit is received when the position is opened. The iron butterfly spread width defines the maximum risk for the strategy. The risk is limited to the spread width minus the premium received. An investor would initiate an iron butterfly when the expectation is the stock price will stay range-bound before expiration and implied volatility will decrease.

How to set up an Iron Butterfly

Iron butterflies are essentially a short straddle with long option protection purchased above and below the short strikes to limit risk. This creates a bear call credit spread and bull put credit spread centered at the same short strike price with the same expiration date. The combined credit of the spreads defines the maximum profit for the trade. The maximum risk is defined by the spread width minus the credit received. 

The wider the spread width between the short option and long option, the more premium will be collected, but the maximum risk will be higher.

Iron butterflies are typically sold at-the-money of the underlying asset. However, they can be entered above or below the stock price to create a bullish or bearish bias.

For example, if a stock is trading at $105, an iron butterfly centered at $100 would be a bearish position because the underlying asset’s price must decline before expiration for the position to realize maximum profit.

Iron Butterfly Payoff Diagram

The iron butterfly gets its name from the payoff diagram, which resembles the body and wings of a butterfly. The profit and loss areas are well defined with an iron butterfly. A credit is collected when entering an iron butterfly. The initial credit received is the maximum profit potential. If the underlying price is above or below one of the long strike prices at expiration, the maximum loss will be realized. The break-even points are determined by the total credit received, above or below the short options. 

For example, if an iron butterfly is opened for a $5.00 credit, the break-even price will be $5.00 above and below the short strikes. 

Any time before expiration, there may be opportunities to exit the position for a profit. This is accomplished by exiting the full position, exiting one spread, or buying back only the short options.

Technically, for an iron butterfly to achieve maximum profit, the underlying stock price would need to close at-the-money of the short options. Because this is unlikely, iron butterflies are typically exited early at a predetermined profit target or days until expiration. For a profit to be realized, the stock price must stay relatively stable or implied volatility decreases.

Image of iron butterfly payoff diagram showing max profit, max loss, and break-even points

Entering an Iron Butterfly

To create an iron butterfly, sell-to-open (STO) a short straddle, buy-to-open (BTO) a call option above the straddle’s strike price, and buy-to-open a put option below the straddle’s strike price. All option contracts have the same expiration date. 

For example, if a stock is trading at $100, a call option and put option could be sold at the $100 strike price, with a long call purchased at the $110 strike price and a long put purchased at the $90 strike price. This would create a $10 wide iron butterfly. If the credit received to enter the trade is $5.00, the max profit would be $500 and the max loss would be -$500.

• Buy-to-open: $90 put
• Sell-to-open: $100 put
• Sell-to-open: $100 call
• Buy-to-open: $110 call

Higher volatility will equate to higher options prices. The longer the expiration date is from the trade’s entry, the more the options will cost, and more premium will be collected when the position is opened.

Exiting an Iron Butterfly

An iron butterfly looks to capitalize on time decay, minimal price movement in a stock, a drop in volatility, or a combination of all three. At expiration, one of the short options will likely be in-the-money and at risk of assignment, so the position must be closed if assignment is to be avoided.

Any time before expiration, the position can be exited by closing the entire iron butterfly, one spread, or just the short strikes. If the options are purchased for less money than they were sold, the position will result in a profit.

Time decay impact on an Iron Butterfly

Time decay, or theta, works to the advantage of the iron butterfly strategy. Every day the time value of an options contract decreases. Ideally, the underlying stock experiences minimal movement, and theta will exponentially lose value as the position approaches expiration. The decline in value may allow the investor to purchase the options contracts for less money than initially sold.

Implied volatility impact on an Iron Butterfly

Iron butterflies benefit from a decrease in implied volatility. Lower implied volatility results in lower option premiums. Ideally, when an iron butterfly is initiated, implied volatility is higher than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the short options.

Adjusting an Iron Butterfly

Iron butterflies can be adjusted to extend the time horizon of the trade or by rolling one of the spreads up or down as the price of the underlying stock moves. If one side of the iron butterfly is deep-in-the-money as the position approaches expiration, an investor has two choices to maximize the probability of success. 

The entire position can be closed and reopened for a later expiration date. Iron butterfly options adjustments typically brings in more credit, which may widen the break-even point, increase the maximum profit potential, and decrease the maximum risk, depending on the adjustment strategy. Contract size and expiration dates must remain the same to maintain the risk profile. 

If one side of the iron butterfly is challenged, the opposing short option could be rolled toward the stock price to receive additional credit. The additional credit will widen the break-even point on the challenged side of the position and reduce risk if the stock does not reverse.

However, because iron butterflies are centered at the same short strike price, adjusting a short option results in the position being “inverted,” meaning the short call is below the short put. When inverted, the distance between the call and put options will be the least amount the position can be repurchased. If the credit received from the initial entry plus the credit received from the inversion is wider than the width of the inversion, the position may result in a profit.

For example, an iron butterfly centered at $100 with a $10 wide spread received $5.00 of credit at trade entry. If the underlying stock price increases, the short put could be rolled up to $102. This would create a $2 inversion.

• Buy-to-close: $100 put
• Sell-to-open: $102 put

Assuming the adjustment brings in an additional $1.00 of credit, the maximum profit potential becomes $400 if the stock closes between $100 and $102 at expiration, because the spread could be purchased for no less than $2.00.

If the stock continues to rise, the risk to the upside is reduced. However, if the $90 long put is not rolled up, the downside risk increases by $200 per contract because the spread between the short put and long put is wider.

Iron Butterfly adjust to to inverted butterfly

Rolling an Iron Butterfly

Iron butterflies can be rolled out to a future expiration date to maximize the potential profit on the trade. Time decay benefits options sellers. If expiration is approaching and the position is not profitable, the original iron butterfly position may be purchased and resold for a future expiration date. This may result in a credit and will extend the trade’s time duration and widen the break-even points. 

For example, if the original iron butterfly is centered at $100 with a June expiration date and received $5.00 of premium, the investor could buy-to-close (BTC) the entire position and sell-to-open (STO) a new position in July. If this results in a credit of $1.00, the maximum profit potential increases and the maximum loss decreases by $100 per contract. The new break-even points will be $94 and $106.

Example of rolling an iron butterfly out to a later expiration date

Hedging an Iron Butterfly

The most efficient way to hedge an iron butterfly is to roll the unchallenged spread in the direction of price movement.

For example, if the price of the underlying stock has moved higher and is challenging the bear call credit spread, the original bull put credit spread could be closed and reopened closer to the current stock price. This will increase the amount of credit received, and if the price of the stock continues higher, the bull put spread will remain profitable, while the bear call spread will lose money.

FAQs

Iron Condor overview

An iron condor consists of selling an out-of-the-money bear call credit spread above the stock price and an out-of-the-money bull put credit spread below the stock price with the same expiration date. 

The strategy looks to take advantage of a drop in volatility, time decay, and little or no movement from the underlying asset. Iron condors are essentially a short strangle with long option protection purchased above and below the short strikes to define risk.

Iron Condor market outlook

Iron condors are market neutral and have no directional bias. An investor would initiate an iron condor when the expectation is the stock price will stay range-bound before expiration and implied volatility will decrease.

How to set up an Iron Condor

An iron condor is created by selling a bear call credit spread and a bull put credit spread out-of-the-money with the same expiration date. The combined credit of the spreads defines the maximum profit for the trade. The maximum risk is defined by the spread width minus the credit received. 

Investors can sell iron condors at any distance from the stock’s current price and with any size spread between the short and long options. The closer the strike prices are to the underlying’s price, the more credit will be collected, but the higher the probability the option will finish in-the-money.

The wider the spread width between the short and long options, the more premium will be collected, but the maximum risk will be higher.

Iron Condor payoff diagram

The iron condor gets its name from the payoff diagram, which resembles a large bird’s body and wings. The profit and loss areas are well defined with an iron condor. If the price closes between the two short strike prices at expiration, the full credit is realized as a profit.

If the underlying price is above or below one of the long strike prices at expiration, the maximum loss will be realized. The break-even points are determined by the total credit received, above or below the short options. 

For example, if an iron condor is opened for a $2.00 credit, the break-even price will be $2.00 above the short call strike and $2.00 below the short put strike. 

Any time before expiration, there may be opportunities to close the position for a profit by exiting the full position, exiting one spread, or buying back only the short options. If the options are purchased for less money than they were sold, the strategy will be profitable.

Image of iron condor payoff diagram showing max profit, max loss, and break-even points

Entering an Iron Condor

Iron condors are created by selling-to-open (STO) a credit spread above and below the current stock price. This involves selling an out-of-the-money option and buying a further out-of-the-money option. 

For example, if a stock is trading at $100, a bull put spread could be opened by selling a put at the $95 strike price and buying a put at the $90 strike price. A bear call spread could be opened by selling a call at the $105 strike price and buying a call at the $110 strike price. This creates a $10 wide iron condor with $5 wide wings. If the credit received to enter the trade is $2.00, the max loss would be -$300, and the max profit potential would be $200.

• Buy-to-open: $90 put
• Sell-to-open: $95 put
• Sell-to-open: $105 call
• Buy-to-open: $110 call

The spreads can be any width and any distance from the current stock price. The closer the strike prices are to the underlying’s price, the more credit will be collected, but the higher the probability the options will finish in-the-money. The larger the width of the spread is between the short option and the long option, the more premium will be collected, but the maximum risk will be higher. The longer the expiration date is from the trade’s entry, the more premium will be collected when the position is opened, but the probability of profit will decline because there is more time for the underlying security to challenge one of the short strike prices.

Exiting an Iron Condor

Iron condors look to capitalize on time decay, minimal price movement in a stock, a drop in volatility, or a combination of all three. If the underlying stock price stays between the short options, the contracts will expire worthless, and the credit received will be kept.

Any time before expiration, there may be opportunities to close the position for a profit by exiting the full position, exiting one spread, or buying back only the short options. If the options are purchased for less money than they were sold, the strategy will be profitable. 

Purchasing long option protection above and below the short strikes defines the position’s risk. The maximum loss is limited to the spread’s width minus the credit received.

If the underlying stock price is beyond the long option at expiration, the spread can be exited, and the max loss will be realized. If one of the short options is in-the-money at expiration and at risk of assignment, the contracts should be purchased if assignment is to be avoided.

Time decay impact on an Iron Condor

Time decay, or theta, works to the advantage of the iron condor strategy. Every day the time value of an options contract decreases. Ideally, the underlying stock experiences minimal movement, and theta will exponentially lose value as the position approaches expiration.

The decline in value may allow the investor to purchase the options contracts for less money than initially sold.

Implied volatility impact on an Iron Condor

Iron condors benefit from a decrease in implied volatility. Lower implied volatility results in a lower option premium. Ideally, when an iron condor is initiated, implied volatility is higher than it is at exit or expiration.

Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options.

Adjusting an Iron Condor

Iron condors can be adjusted by extending the time horizon of the trade or by rolling one of the spreads up or down as the price of the underlying stock moves. Adjusting an iron condor typically brings in more credit, which increases the maximum profit potential, decreases the maximum risk, and widens the break-even points.

However, the position’s range of profitability decreases as the iron condor’s width tightens.

Contract size and expiration dates must remain the same to maintain the original position’s risk profile.

If one side of the iron condor is challenged as the contracts approach expiration, an investor has two choices to maximize the probability of success: roll out the position to a later expiration date or roll one of the credit spreads toward the stock price.

The entire position can be closed and reopened for a later expiration date. If this results in a credit, the break-even points will be extended by the premium received. 

If one side of the iron condor is challenged, the opposing side could be rolled in the stock price direction to receive additional credit.

For example, if the stock is trading lower, the $105 / $110 call credit spread could be closed, and a new spread opened at a lower price. This will tighten the width of the iron condor, but the additional credit received will decrease the position’s risk.

• Buy-to-close: $105 call
• Sell-to-close: $110 call
• Sell-to-open: $100 call
• Buy-to-open: $105 call

If the adjustment brings in an additional $1.00 of credit, the maximum profit potential increases by $100 per contract, and the maximum loss decreases by $100 per contract. The break-even point for the put spread increases by the amount of credit received.

Image of an iron condor with the call spread adjusted down

Conversely, if the stock is trading higher, the $95 / $90 put credit spread could be closed, and a new spread opened at a higher price. This will tighten the width of the iron condor, but the additional credit received will decrease the position’s risk.

• Sell-to-close: $90 put
• Buy-to-close: $95 put
• Buy-to-open: $95 put
• Sell-to-open: $100 put

If the adjustment brings in an additional $1.00 of credit, the maximum profit potential increases by $100 per contract, and the maximum loss decreases by $100 per contract. The break-even point for the call spread increases by the amount of credit received.

Image of an iron condor with the put spread adjusted up

If the underlying stock’s price has moved substantially, an iron condor can be converted into an iron butterfly by closing one of the spreads and centering the short strikes at the same price.

An iron condor adjusted to an iron butterfly will have the most profit potential and least amount of risk, but the position’s range of profitability ($101 – $109) is smaller than an iron condor.

• Sell-to-close: $90 put
• Buy-to-close: $95 put
• Buy-to-open: $100 put
• Sell-to-open: $105 put

If the adjustment brings in an additional $2.00 of credit, the maximum profit potential increases by $200 per contract, and the maximum loss decreases by $200 per contract. The break-even point for the unadjusted spread will increase by the amount of credit received.

Image of an iron condor converted into an iron butterfly

Rolling an Iron Condor

Iron condors can be rolled out to a future expiration date to maximize the trade’s potential profit. Time decay benefits options sellers. If expiration is approaching and the position is not profitable, the original iron condor position may be purchased and reopened for a future expiration date.

This may result in a credit and will extend the trade’s time duration and widen the break-even points. 

For example, if the original iron condor has a $105 / $110 call spread and a $95 / $90 put spread with a June expiration date and received $2.00 of premium, an investor could buy-to-close (BTC) the entire iron condor and sell-to-open (STO) a new position in July.

If this results in a credit of $1.00, the maximum profit potential increases and the maximum loss decreases by $100 per contract. The new break-even points will be $92 and $108.

Example of rolling out an iron condor to a later expiration date

Hedging an Iron Condor

The most efficient way to hedge an iron condor is to roll the unchallenged spread in the direction of the underlying stock’s price movement.

For example, if the underlying stock price has moved higher and is challenging the bear call spread, the original bull put spread could be closed and reopened closer to the current stock price.

This will increase the amount of credit received, and if the price of the stock continues higher, the bull put spread will remain profitable, while the bear call spread will lose money.

FAQs

Short Strangle overview

Short strangles consist of selling an out-of-the-money short call and an out-of-the-money short put for the same expiration date. The strategy capitalizes on minimal stock movement, time decay, and decreasing volatility.

Short Strangle market outlook

Short strangles are market neutral and have no directional bias. Short strangles require minimal movement from the underlying stock to be profitable. Credit is received when the position is opened. Beyond the premium collected, the risk is unlimited above and below the strike prices.

How to set up a Short Strangle

A short strangle consists of a short call option and a short put option with the same expiration date. The short options are typically sold out-of-the-money above and below the stock price. The combined credit of the short call and short put define the maximum profit for the trade. The maximum risk is undefined beyond the credit received.

Short Strangle payoff diagram

The short strangle payoff diagram resembles an upside-down “U” shape. The maximum profit on the trade is limited to the initial credit received. The maximum risk is undefined beyond the credit received. The break-even point for the trade is the combined credit of the two options contracts above or below each strike price.

For example, if a stock is trading at $100, a put option could be sold at $95 and a call option sold at $105. If the position received a total credit of $5.00, the break-even points for this trade would be $90 and $110.

Image of short strangle payoff diagram showing max profit, max loss, and break-even points

The short strangle could be closed anytime before expiration by purchasing the short options. If the cost of buying the contracts is less than the initial credit received, the position will result in a profit. Implied volatility will have an impact on the price of the options. If implied volatility decreases, the options contracts’ price will decrease as well, which benefits an options seller.

Entering a Short Strangle

To enter a short strangle, sell-to-open (STO) a short call above the current stock price and sell-to-open (STO) a short put below the current strike price for the same expiration date. For example, if a stock is trading at $100, a call option could be sold at $105 and a put option sold at $95. Higher volatility will equate to higher option prices. The longer the expiration date is from trade entry, the more the options will cost, and the more premium will be collected when sold.

• Sell-to-open: $95 put
• Sell-to-open: $105 call

Exiting a Short Strangle

A short strangle looks to capitalize on time decay, minimal price movement in a stock, a drop in volatility, or a combination of all three. If the underlying stock price stays between the short options, the contracts will expire worthless at expiration, and all credit received will be kept.

Any time before the expiration, the position can be exited with a buy-to-close (BTC) order of one or both contracts. If the options are purchased for less money than they were sold, the strategy will be profitable.

If either option is in-the-money (ITM) at expiration, the contract will be automatically assigned.

Time decay impact on a Short Strangle

Time decay, or theta, works in the advantage of the short strangle strategy. Every day the time value of an options contract decreases. Ideally, the underlying stock experiences minimal movement, and theta will exponentially lose value as the options approach expiration. The decline in value may allow the investor to purchase the options contracts for less money than initially sold.

Implied volatility impact on a Short Strangle

Short strangles benefit from a decrease in the value of implied volatility. Lower implied volatility results in lower options premium prices. Ideally, when a short strange is initiated, implied volatility is higher than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the strangle options.

Adjusting a Short Strangle

Short strangles can be adjusted by rolling one leg of the option up or down as the price of the underlying stock moves. If one side of the short strangle is challenged as the contracts approach expiration, an investor can manage the position to maximize the probability of success.

If one side of the strangle is challenged, the opposing side could be closed and reopened closer to the stock price. Adjusting the position will result in additional credit.

For example, if the stock is trading lower and challenging the $95 short put, the $105 short call option could be closed and a new call option sold at a lower price. This will tighten the width of the spread, but additional credit will be received to help offset the smaller profit zone.

• Buy-to-close: $105 call
• Sell-to-open: $100 call

Short strange with call option adjusted down

Conversely, if the stock is trading higher and challenging the $105 short call, the $95 short put option could be closed and a new put option sold at a higher price. This will tighten the width of the spread, but additional credit will be received to help offset the smaller profit zone.

• Buy-to-close: $95 put
• Sell-to-open: $100 put

Short strange with put option adjusted up

If the underlying asset has moved significantly, the short strangle could be converted to a short straddle by closing the unchallenged short option and selling an option with the same strike price as the challenged side of the position.

For example, if the stock price has increased beyond the short call strike price, the $95 short put could be closed and a put could be opened with a $105 strike price. This will increase the credit and expand the break-even point up for the challenged side of the position. The maximum risk is still undefined, but the additional credit helps offset the loss.

• Buy-to-close: $95 put
• Sell-to-open: $105 put

If the adjustment collects an additional credit of $2.00, the new break-even points will be $98 and $112.

Short strangle adjusted to a short straddle

Rolling a Short Strangle

The short options of a strangle can be rolled out into the future to extend the trade’s duration. The passing of time works in favor of an options seller. But if time is running out before expiration and the position is not profitable, the original strangle may be closed and reopened for a future expiration date. This will likely result in a credit and widen the profit zone.

For example, if the original short strangle has a $105 call and $95 put with a June expiration date and received $5.00 of premium, the investor could buy-to-close (BTC) the call and put option, and sell-to-open (STO) a new position in July. If this results in a $1.00 credit, the new break-even points will be $89 and $111.

Short strangle roll out to a later expiration for a credit

Hedging a Short Strangle

Hedging short strangles can define the risk of the trade if the underlying stock price has moved beyond the profit zone. To hedge against further risk, an investor may choose to purchase a long option to create a credit spread on one or both sides of the short strangle.

For example, if the short put has a $95 strike price ,and the stock is challenging the short put’s strike, a long put with a $90 strike price could be purchased to limit risk if the stock continues lower. If the short strangle collected a premium of $5.00 at trade entry, and the long put cost $3.00, the break-even points would tighten to $93 and $107. The maximum profit potential is reduced to $200, but the maximum loss below the long put is the spread width of the put options, minus the overall credit received ($300). However, the max risk is still undefined above the short call if the stock reverses higher.

• Buy-to-open: $90 put

Short strangle adjusted to a broken-wig condor purchasing long put protection

Conversely, if the stock price increases, a long call with a $110 strike price could be purchased to define risk if the stock continues higher. If the long call cost $3.00, the max profit potential is reduced to $200 and the max loss becomes the spread width of the call options, minus the overall credit received ($300). The max risk remains undefined below the short strikes if the stock reverses lower.

• Buy-to-open: $110 call

Short strangle adjusted to a broken-wig condor purchasing long call protection

FAQs

Short Straddle overview

Short straddles consist of selling a short call and a short put at the same strike price for the same expiration date. The strategy capitalizes on minimal stock movement, time decay, and decreasing volatility.

Short Straddle market outlook

Short straddles are market neutral and have no directional bias. Short straddles require minimal movement from the underlying stock to be profitable. Credit is received when the position is opened. Beyond the premium collected, the risk is unlimited in both directions.

How to set up a Short Straddle

A short straddle consists of a short call option and a short put option with the same strike price and expiration. Short straddles are typically sold at-the-money of the underlying asset. However, a short straddle can be opened above or below the stock price to create a bullish or bearish bias.

For example, if a stock is trading at $95, a short straddle centered at $100 would be a bullish position because the underlying asset’s price must increase before expiration for the position to realize maximum profit.

The combined credit of the short call and short put defines the maximum profit for the trade. The maximum risk is undefined beyond the credit received.

Short Straddle payoff diagram

The short straddle payoff diagram resembles an upside-down “V” shape. The maximum profit on the trade is limited to the initial credit received. The maximum risk is undefined beyond the credit received. The break-even point for the trade is the combined credit of the two options contracts above and below the strike price.

For example, if a stock is trading at $100, a call and put option could be sold with a $100 strike price to create a short straddle. If the sale of the short straddle results in a $10.00 credit, the break-even prices would be $90 and $110.

The short straddle could be exited anytime before expiration by purchasing the short options. If the cost of buying the contracts is less than the initial credit received, the position will result in a profit.

Implied volatility will have an impact on the price of the options. As implied volatility decreases, the options contracts’ price will decrease as well, which works in favor of an options seller.

Image of short straddle payoff diagram showing max profit, max loss, and break-even points

Entering a Short Straddle

To enter a short straddle, sell-to-open (STO) a short call and a short put simultaneously at the same strike price and expiration date. For example, if a stock is trading at $100, a call option and put option could be sold at $100.

• Sell-to-open: $100 call
• Sell-to-open: $100 put

Higher volatility will equate to higher option prices. The longer the expiration date is from trade entry, the more the options will cost, and the more premium will be collected when sold.

Exiting a Short Straddle

A short straddle looks to capitalize on time decay, minimal price movement in a stock, a drop in volatility, or a combination of all three. At expiration, one of the short options will be in-the-money and at risk of assignment, so the position must be closed if assignment is to be avoided.

Any time before expiration, the position can be closed with a buy-to-close (BTC) order. If the options are purchased for less money than they were sold, the position will result in a profit.

Time decay impact on a Short Straddle

Time decay, or theta, works in the advantage of the short straddle strategy. Every day the time value of an options contract decreases. Ideally, the underlying stock experiences minimal movement, and theta will exponentially lose value as the options approach expiration. The decline in value may allow the investor to purchase the options contracts for less money than initially sold.

Implied volatility impact on a Short Straddle

Short straddles benefit from a decrease in the value of implied volatility—lower implied volatility results in lower options premium prices. Ideally, when a short straddle is initiated, implied volatility is higher than at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the straddle options.

Adjusting a Short Straddle

Short straddles can be adjusted to extend the time horizon of the trade or by rolling one of the spreads up or down as the price of the underlying stock moves. If one side of the straddle is deep-in-the-money as the position approaches expiration, an investor has two choices to maximize the probability of success.

The entire position can be closed and reopened for a later expiration date. Adjusting a short straddle typically brings in more credit, which increases the maximum profit potential, decreases the maximum risk, and widens the break-even point. Contract size and expiration dates must remain the same to maintain the risk profile.

If one side of the straddle is challenged, the opposing short option could be rolled toward the stock price to receive additional credit. The additional credit widens the break-even point on the challenged side of the position and reduces overall risk, but the max loss remains undefined in either direction.

However, because short straddles are centered at the same strike price, adjusting one of the short options creates an “inverted” position, meaning the short call is below the short put. When inverted, the distance between the call and put options will be the least amount the position can be repurchased. If the credit received from the initial entry plus the credit received from the inversion is wider than the width of the inversion, the position may result in a profit.

For example, a short straddle centered at $100 received $10.00 of credit at trade entry. If the underlying stock price increases, the short put could be rolled up to $105. This creates a $5 inversion.

• Buy-to-close: $100 put
• Sell-to-open: $105 put

Assuming the adjustment brings in an additional $1.00 of credit, the maximum profit potential becomes $600 if the stock closes between $100 and $105 at expiration, because the spread could be purchased for no less than $5.00.

Short straddle adjusted to inverted straddle

Rolling a Short Straddle

The short options of a straddle can be rolled out to extend the trade’s duration. Time decay benefits short strategies. If the position is not profitable as expiration approaches, the original straddle may be closed and reopened with a future expiration date. This will likely result in a credit and widen the profit zone.

For example, if the original short straddle is centered at $100 with a June expiration date, and received $10.00 of premium, the investor could buy-to-close (BTC) the call and put option, and sell-to-open (STO) a new position in July. If this results in a $2.00 credit, the new break-even points will be $88 and $112.

Short straddle rolled out to a later expiration date for a credit

Hedging a Short Straddle

Hedging a short straddle defines the risk of the trade if the underlying stock price has moved beyond the profit zone. To hedge against further risk, an investor may choose to purchase a long option to create a credit spread on one or both sides of the position.

For example, if the short straddle is centered at $100, and the stock is challenging the position, a long call with a $110 strike price could be purchased to limit risk if the stock continued higher. If the short straddle collected a premium of $10.00 at trade entry, and the the long call cost $5.00, the break-even points would tighten to $95 and $105. The maximum profit potential is reduced to $500, but the maximum loss above the long call is the spread width of the call options, minus the overall credit received ($500). However, the max risk is still undefined below the short put if the stock reversed lower.

• Buy-to-open: $110 call

Short straddle adjusted to a broken wing butterfly. Long call purchased

Conversely, if the stock price declined, a long put with a $90 strike price could be purchased to define risk if the stock continued lower. If the long put cost $5.00, the max profit potential is reduced and the max loss becomes the spread width of the put options, minus the overall credit received ($500). The max risk is still undefined above the short strikes if the stock reversed higher.

• Buy-to-open: $90 put

Short straddle adjusted to a broken wing butterfly. Long put purchased

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