Module 6 Option Strategies

Chapter 11

The Short Straddle

169

11.1 – Context

In the previous chapter we understood that for the long straddle to be profitable, we need a set of things to work in our favor, reposting the same for your quick reference –

  1. The volatility should be relatively low at the time of strategy execution
  2. The volatility should increase during the holding period of the strategy
  3. The market should make a large move – the direction of the move does not matter
  4. The expected large move is time bound, should happen quickly – well within the expiry
  5. Long straddles are to be setup around major events, and the outcome of these events to be drastically different from the general market expectation.

Agreed that the directional movement of the market does not matter in the long straddle, but the bargain here is quite hard. Considering the 5 points list, getting the long straddle to work in you favor is quite a challenge.  Do recall, in the previous chapter the breakdown was at 2%, add to this another 1% as desired profits and we are essentially looking for, at least a 3% move on the index. From my experience expecting the market to make such moves regularly is quite a challenge. In fact for this reason alone, I think twice each and every time I need to initiate a long straddle.

I have witnessed many traders recklessly set up long straddles thinking they are insulated to the market’s directional movement. But in reality they end up losing money in a long straddle – time delay and the general movement in the market (or the lack of it) works against them. Please note, I’m not trying to discourage you from employing the long straddle, no one denies the simplicity and elegance of a long straddle. It works extremely well when all the 5 points above are aligned. My only issue with long straddle is the probability of these 5 points aligning with each other.

Now think about this – there are quite a few factors which prevents the long straddle to be profitable. So as an extension of this – the same set of factors ‘should’ favor the opposite of a long straddle, i.e the ‘Short Straddle’.

M6-Ch11-cartoon

11.2 – The Short Straddle

Although many traders fear the short straddle (as losses are uncapped), I personally prefer trading the short straddle on certain occasions over its peer strategies. Anyway let us quickly understand the set up of a short straddle, and how its P&L behaves across various scenarios.

Setting up a short straddle is quite straight forward – as opposed to buying the ATM Call and Put options (like in long straddle) you just have to sell the ATM Call and Put option. Obviously the short strategy is set up for a net credit, as when you sell the ATM options, you receive the premium in your account.

Here is any example, consider Nifty is at 7589, so this would make the 7600 strike ATM. The option premiums are as follows –

  • 7600 CE is trading at 77
  • 7600 PE is trading at 88

So the short straddle will require us to sell both these options and collect the net premium of 77 + 88 = 165.

Please do note – the options should belong to the same underlying, same expiry, and of course same strike. So assuming you have executed this short straddle, let’s figure out the P&L at various market expiry scenarios.

Scenario 1 – Market expires at 7200 (we lose money on put option)

This is a scenario where the loss in the put option is so large that it eats away the premium collected by both the CE and PE, resulting in an overall loss. At 7200 –

  • 7600 CE will expire worthless, hence we get the retain the premium received i.e 77
  • 7600 PE will have an intrinsic value of 400. After adjusting for the premium received i.e Rs.88, we lose 400 – 88 = – 312
  • The net loss would be 312 – 77 = – 235

As you can see, the gain in call option is offset by the loss in the put option.

Scenario 2 – Market expires at 7435 (lower breakdown)

This is a situation where the strategy neither makes money nor loses any money.

  • 7600 CE would expire worthless; hence the premium received is retained. Profit here is Rs.77
  • 7600 PE would have an intrinsic value of 165, out of which we have received Rs.88 as premium, hence our loss would be 165 – 88 = -77
  • The gain in the call option is completely offset by the loss in the put option. Hence we neither make money nor lose money at 7435.

Scenario 3 – Market expires at 7600 (at the ATM strike, maximum profit)

This is the most favorable outcome for a short straddle. At 7600, the situation is quite straight forward as both the call and put option would expire worthless and hence the premium received from both the call and put option will be retained. The gain here would be equivalent to the net premium received i.e Rs.165.

So this means, in a short straddle you make maximum money when the markets don’t move!

Scenario 4 – Market expires at 7765 (upper breakdown)

This is similar to the 2nd scenario we discussed. This is a point at which the strategy breaks even at a point higher than the ATM strike.

  • 7600 CE would have an intrinsic value of 165, hence after adjusting for the premium received of Rs. 77, we stand to lose Rs.88 (165 – 77)
  • 7600 PE would expire worthless, hence the premium received i.e Rs.88 is retained
  • The gain made in the 7600 PE is offset against the loss on the 7600 CE, hence we neither make money nor lose money.

Clearly this is the upper breakdown point.

Scenario 5 – Market expires at 8000 (we lose money on call option)

Clearly the market in this scenario is way above the 7600 ATM mark. The call option premium would swell, so would the loss –

  • 7600 PE will expire worthless, hence the premium received i.e Rs.88 is retained
  • At 8000, the 7600 CE will have an intrinsic value of 400, hence after adjusting for the premium received of Rs. 77, we stand to lose Rs. 323( 400 -77)
  • We have received Rs.88 as premium for the Put option, therefore the loss would be 88- 323 = -235

So as you can see, the loss in the call option is significant enough to offset the combined premiums received.

Here is the payoff table at different market expiry levels.

Image 1_payoff

As you can observe –

  1. The maximum profit 165 occurs at 7600, which is the ATM strike
  2. The strategy remains profitable only between the lower and higher breakdown numbers
  3. The losses are unlimited in either direction of the market

We can visualize these points in the payoff structure here –

Image 2_payoff chart

From the inverted V shaped payoff graph, the following things are quite clear –

  1. The point at which you can experience maximum profits is at ATM, the profits shrink as you move away from the ATM mark
  2. The strategy is profitable as long as the market stays within the breakdown points
  3. Maximum loss is experienced when markets move further away from the breakdown point. The further away the market moves from the breakdown point, higher the loss
    1. Max loss = Unlimited
  4. There are two breakdown points – on either side, equidistant from ATM
    1. Upper Breakdown = ATM + Net premium
    2. Lower Breakdown = ATM – Net premium

As you may have realized by now, the short straddle works exactly opposite to the long straddle. Short straddle works best when markets are expected to be in a range and not really expected to make a large move.

Many traders fear short straddle considering the fact that short straddles have unlimited losses on either side. However from my experience, short straddles work really well if you know how exactly to deploy this. In fact in the last chapter of the previous module, I had posted a case study involving short straddle. Probably that was one of the best examples of when to implement the short straddle.

I will repost the same again here and I hope you will be able to appreciate the case study better.

11.3 – Case Study (repost from previous module)

The following case study was a part of Module 5, Chapter 23. I’m reposting the same here as I assume you would appreciate the example better at this stage. To get the complete context, I’d request you to read the chapter.

Infosys was expected to announce their Q2 results on 12th October. The idea was simple – news drives volatility up, so short options with an expectation that you can buy it back when the volatility cools off. The trade was well planned and the position was initiated on 8th Oct – 4 days prior to the event.

Infosys was trading close to Rs.1142/- per share, so he decided to go ahead with the 1140 strike (ATM).

Here is the snapshot at the time of initiating the trade –

Image 3

On 8th October around 10:35 AM the 1140 CE was trading at 48/- and the implied volatility was at 40.26%. The 1140 PE was trading at 47/- and the implied volatility was at 48%. The combined premium received was 95 per lot.

Market’s expectation was that Infosys would announce fairly decent set of numbers. In fact the numbers were better than expected, here are the details –

“For the July-September quarter, Infosys posted a net profit of $519 million, compared with $511 million in the year-ago period. Revenue jumped 8.7 % to $2.39 billion. On a sequential basis, revenue grew 6%, comfortably eclipsing market expectations of 4- 4.5% growth.

In rupee terms, net profit rose 9.8% to Rs.3398 crore on revenue of Rs. 15,635 crore, which was up 17.2% from last year”. Source: Economic Times.

The announcement came in around 9:18 AM, 3 minutes after the market opened, and this trader did manage to close the trade around the same time.

Here is the snapshot –

Image 4

The 1140 CE was trading at 55/- and the implied volatility had dropped to 28%. The 1140 PE was trading at 20/- and the implied volatility had dropped to 40%.

Do pay attention to this – the speed at which the call option shot up was lesser than the speed at which the Put option dropped its value. The combined premium was 75 per lot, and he made a 20 point profit per lot.

11.4 – The Greeks

Since we are dealing with ATM options, the delta of both CE and PE would be around 0.5. We could add the deltas of each option and get a sense of how the overall position deltas behave.

  • 7600 CE Delta @ 0.5, since we are short, the delta would be -0.5
  • 7600 PE Delta @ – 0.5, since we are short, the delta would be + 0.5
  • Combined delta would be -0.5 + 0.5 = 0

The combined delta indicates that the strategy is directional neutral. Remember both long and short straddle is delta neutral. In case of long straddle, delta neutral suggests that the profits are uncapped and in case of short straddle, the losses are uncapped.

Now here is something for you to think about – When you initiate a straddle you are obviously delta neutral. But as the markets move, will your position still remain delta neutral? If yes, why do you think so? If no, then is there a way to keep the position delta neutral?

If you can build your thoughts around these points, then I can guarantee you that your options knowledge is far greater than 90% of the market participants. To answer these simple questions, you will need to step a little deeper and get into 2nd level of thinking.

Do post your comments below.


Key takeaways from this chapter

  1. Short straddle requires you to simultaneously Sell the ATM Call and Put option. The options should belong to the same underlying, same strike, and same expiry
  2. By selling the CE and PE – the trader is placing the bet that the market wont move and would essentially stay in a range
  3. The maximum profit is equal to the net premium paid, and it occurs at the strike at which the long straddle has been initiated
  4. The upper breakdown is ‘strike + net premium’. The lower breakdown is ‘strike – net premium’
  5. The deltas in a short straddle adds up to zero
  6. The volatility should be relatively high at the time of strategy execution
  7. The volatility should decrease during the holding period of the strategy
  8. Short straddles can be set around major events, wherein before the event, the volatility would drive the premiums up and just after the announcement, the volatility would cool off, and so would the premiums.

Download Short Straddle Excel Sheet

169 comments

  1. Darshan says:

    As the market moves, position won’t be delta neutral any longer. In order to bring the position back to delta neutral one can make use FUTURE as it carries delta of 1. Options can also be used for the same. This strategy is a very good strategy for traders who just want to earn the TIME VALUE OF MONEY. The only catch is it is a very HIGH RISK – HIGH REWARD strategy.

    • Karthik Rangappa says:

      True! You got to use future 🙂

      • Arun Prasath says:

        Hey Karthik,

        Thanks for publishing this, can you help me understand with an example how using Futures will help us achieve Delta neutral?

        Thank you!

        • Karthik Rangappa says:

          Futures has a delta of 1 and the delta of an option varies between 0 and 1 (+ve for long options and -ve for short options). So for example, if I have shorted 2 options with Delta of – 0.5, then the overall delta would be –

          -0.5 + (-0.5)
          -1.0

          Now along with this if you buy a futures, then the overall delta will be 1 – 1 = 0. Hence delta neutral.

          • Akash says:

            Let say for the infy example,as the market moved the CE becomes ITM and delta goes to 0.8 and the PE the delta goes to -0.3, the net delta is 0.5…how would buying a future option help in this case?

          • Karthik Rangappa says:

            The delta of Futures is 1. To have a Delta Neutral position, you need to offset the options delta of 0.5 with Futures delta of 1, which means to say you need to add more options position to boost the overall position delta to 1.

          • kaavee says:

            Can’t you just take the appropriate ratio of futures, let’s say delta became -0.2, then long futures with 0.2 size of the option positions

          • Karthik Rangappa says:

            Delta of futures is fixed to 1.

  2. sastry says:

    Sir,
    (1)When the trend moves in UP direction, we can observe the following:
    the ATM strike price premium at which the CALL option purchased, will become costlier due to increase of DELTA from 0.5 to 1.0 by moving the strike into ITM strike depending upon the increment and vice versa of the opposite direction ie PUT option by decreasing the DELTA than(-) 0.5 to 0 becoming the premium cheaper.
    (2) To equalise the strategy we adjust the straddle by adding more DELTAS ie by selling put strikes.
    Please correct me if wrong. Regards, Sastry

  3. sastry says:

    Sir,
    Part 2 of my question ie will you please how to adjust with Futures (Nifty index) to DElta Neutral. I will be highly grateful if you can let me have your reply. Regards, Sastry

    • Karthik Rangappa says:

      Adjusting Futures in order to retain the straddle delta neutral is called ‘Delta Hedging’. I will need a separate chapter to explain this in detail 🙂

  4. chetan solanki says:

    Nice article on the related chapter…. very well explained.

  5. ABHIJIT SEN says:

    Hi Karthik,

    In my understanding of the things, answer to your question “When you initiate a straddle you are obviously delta neutral. But as the markets move, will your position still remain delta neutral?” is NO. The delta doesn’t remain neutral as markets move away making the contracts ITM & OTM.

    Is it therefore worth considering that on a daily basis, one keeps tracking the change in the underlying (Nifty in this case) and re-position the Stradle by EOD.

    Shall appreciate any other strategy that is more efficient.

  6. Shrekanth says:

    Hii Karthik,
    I have a different query not related to this perticular topic. Is it worth buying ITM or ATM put options in same qty as of the future long qty in order to hedge the down side risk? Is this called as the’ protective put’ strategy? Can we use this strategy in Nifty future break out trades, intraday or positional? Appreciate your kind advice. …

    • Karthik Rangappa says:

      Firstly the quantity will be the same as all derivatives contracts (both Future and options) are standardized.

      Yes, this is a protective put. You can use this in anticipation of a breakout. It the breakout happens and Nifty starts moving in your anticipated direction, then close the put and hold the futures.

      • Santhosh says:

        This regarding short straddle adjustment. Suppose I create a short straddle targeting 2 days after initiation of straddle ( not for expiry day). So I want the market to be within a certain range after considering all the greeks in those 2 days. Suppose the srock price reaches to my upper break even. Then I buy equity stocks and make it delta neutral. That means I can never loose money in this? That can not happen. So what is the catch. How would I loose money even after adjusting delta?

  7. Shrekanth says:

    Thanks for the reply. Hope this is a limited loss and unlimited profit strategy. I think th max loss occurs when the market trades flat. Max loss will b equal to th premium paid for th put option. Kindly correct If I am wrong. Also plz tell me what will be the approximate delta value for a protective put while initiation. Thanks. .

    • Karthik Rangappa says:

      I’d suggest you put these numbers on excel and check how the payoff works out. From the payoff you can visualize all the critical points – breakeven, max profit, max loss etc. I can assure you this will be a great learning experience for you!

  8. Shrekanth says:

    Thank you Karthik. Can you plz tell me where I find pay off shet of covered call and protective put strategis. Or else , if possible, would you plz send it to my mail Id, if you have th same. Thanks..

  9. khyati verdhan says:

    hi kartik,
    how many chapters are left on this module??? when will you start commodity module???

  10. Dilip18 says:

    Arranging of live options trading course will be possible????

  11. sai says:

    Hi Karthik,
    Does it make sense to use long/short saddles for interday? are these strategies only useful for swing/hold until expiry?
    thanks!

  12. Sunil Tyagi says:

    I was just wondering that would it be wise to execute a short-straddle on last day of expiry; considering that the index is not likely to change too much in just one day.

  13. Chandan says:

    Since selling a strike price involves more money than buying the call or put and also the reward is less and loss is uncapped, doesn’t it make the short Straddle dangerous to execute ? We would need to keep a close eye on the levels or else the loss will take over.

    Also among the Long & the Short Straddle which one is better to execute at the start and end of the series ?

    • Karthik Rangappa says:

      This really depends on how you look at it. Yes, when you sell options risk is higher, tends to give you sleepless nights, but the chances of retaining the premiums (if done right) is higher.

      You cannot differentiate the straddles, both these are great strategies, but they work well under different circumstances.

  14. Kavi says:

    What is role of implied volatile in sort straddle can u explain me ?

    • Karthik Rangappa says:

      When you short an option or an option strategy as such, knowingly or unknowingly you are taking a view on the volatility. If you feel the IV is high, shorting makes sense…otherwise it does now. Suggest you read the chapter on Volatility in the previous module.

  15. kiran ravindra nagare says:

    sir in my short straddle pos. my call is deep itm. My debit amt is grater than credit amt then hw can i manage this loss?

  16. PROMIT BANERJEE says:

    Hi Respected Team,
    I am already a fan of Zerodha Varsity. Regarding the Short Straddle Strategy,
    Suppose,
    Short 7600 CE @ 77 (NIFTY)
    Short 7600 PE @ 88 (NIFTY)
    Now, Current Spot Price = 7800.
    Hence, P/L on the CE,
    We make a Loss of 7800-7600=200
    200-Premium Received= 200-78=122
    LOSS = 122
    P/L on the PE,
    We retain the Premium Receiced = 88

    Total Loss on the trade= 122-88=(34)

    Now when Spot is 7800,
    7600 CE is slightly ITM, hence Delta will be around +.7
    As we are short then Delta is (-.7)

    7600 PE is slightly OTM when Spot is 7800.
    Hence, Delta may be around -.4
    As we short, Delta is = +.4
    Total Delta of the the strategy = -.7+.4=.3
    Now as is has been stated earlier that we need Futures to hedge the Delta,
    So we know Delta of Futures is always 1.
    So how we hedge the (0.3) Delta.?
    Plzz Reply.

    • Karthik Rangappa says:

      You can hedge this buy adding another lot of PEs. By the way, in this situation, the CE delta will be higher than -0.7 and the PE delta will be lesser than +0.4.

      • Kanika Agarwal says:

        Hello Karthik,

        Once again a ‘never disappointing, flawless and interesting’ article and explanation. Sincere thanks for this.

        I have one doubt though. Is hedging through futures or underlying stock itself somehow more effective than delta hedging through options because in my understanding, in the above example selling an OTM put (as you also mentioned) or buying an OTM call should serve the purpose of making the whole set-up delta neutral and then there will be no need for futures?

        • Karthik Rangappa says:

          Thanks, Kanika.

          The problem with options is that once you initiate a delta neutral position, you will have to ensure that the position remains delta neutral. With the change in price, the neutrality also changes and this further adds to the trading expense.

  17. Mohit Khandelwal says:

    Hello Sir

    13 April is when the Infosys results are to be declared and I am thinking to execute the position on Monday. If the results are positive then the market is going to bounce 40-50 points according to my calculation but if it is not good it will drop further more. Also from the past results I analyzed that the market tend to sense the results positivity/negativity a day before therefore rise/drop according to that the day on which the results are declared. I confused which strategy shall I choose Bear Call Ladder or Straddle/Strangles as IV for a 980 CE is 31 and 980 PE is also around 30. How do I know whether 30 is low or high? I checked on NSE but I am not getting previous days’ option chain with implied volatility. Do you have any site or source from where I can check and verify the data that 30 is relatively low or high.
    So query
    1) Source/Site where I can check past option chain data so that I can back test
    2) What would you have done I you were at my position. i.e. which strategy would you opt for?

    Thank You

    • Karthik Rangappa says:

      1) No, I’m not aware of any site which displays the IV info.
      2) I would short a straddle/strangle and let the events unfold. Will also make sure the position is closed right after the event is announced.

  18. indiatimes says:

    sir, i just want a moderate return on my capital because of banks FD rates , So i started selling deep OTMs of call and put premium lets say 10 or 6 rupess , i am working on this from last three months is it good or not in long term , please enlighten me from your experience .
    thanks

    • Karthik Rangappa says:

      Yes, it does. But the problem here is that deep OTM can trigger some severe panic if prices starts to move. So be aware of that. Good luck.

  19. Pankit Shah says:

    I had executed short straddle option strategy yesterday.I sold nifty 9500 ce at ₹65 & 9500 pe at ₹49,so total premium recd was ₹114.So I should be profitable if market remains between 9386 & 9614.
    Am I correct? But today the 9500 ce closed at 28.90 & 9500 pe closed at 92.20..so total premium is 121.10..so I would be making loss even though the nifty is between the upper the lower break even.
    Why should it be so…pls explain?

    Regards
    pankit shah

    • Karthik Rangappa says:

      Yes, you would be profitable if Nifty is between the lower and upper bound….on expiry day! During the expiry, remember there are many different factors that will influence the premiums. So your profitability can vary.

  20. Karthik says:

    Hello
    Firstly, great work on the Varsity. Just amazing, keep going.
    Now, I was thinking about the reason why the Volatility drop on the Call Option of the INFY was more compared to the Put Option?
    Is it because of the Impact Cost or Can I relate this to the Open Interest ?
    Is there any way I can predict the magnitude of fall in the Volatility?

    Thanks

    • Karthik Rangappa says:

      Thanks for the kind words 🙂

      This can be attributed to both Volatility + the delta effect. Yes, you can make a fair assessment on how much the volatility is likely to increase or decrease. Things like volatility cone helps here.

  21. kartik says:

    Is it possible to place both the call and put sell order of same strike price in one click on kite??

  22. Pratik Modi says:

    Hi Karthik,
    Thanks for sharing excellent knowledge about options but can you please suggest us any good book reading in order to understand option theory and its strategies more in-depth.?.

  23. Murtuza Shaikh says:

    Hi Sir,
    I wanted to know that to be profitable by using delta neutral strategy the underlying asset should move by a large amount in any direction or just a slight movement in underlying is enough.

    • Karthik Rangappa says:

      Large moves would make more sense for Delta neutral strategies.

      • Murtuza Shaikh says:

        What all factors to be kept in mind while implementing a Delta Neutral strategy. ?

        I first came across this term “Delta Neutral strategy” in an interview of Nikhil Kamath which was interviewed by you. So I am more interested to know about it.

        • Karthik Rangappa says:

          The only factor you need to keep in mind is to ensure that you are totally insulated from the directional movements in the market. The moment you expose yourself to market variations, you are not delta neutral. Another key thing is to make sure you continue to remain delta neutral after taking on the trade.

  24. Rohit says:

    Hello Karthik,

    Is there a way I can have charting for straddle/strangle premium on kite?
    I am sure many option traders will love to have this.
    I was wondering if I could plot a chart that is the sum of premiums of any two options, that way I could construct my own price chart.

    Thanks

  25. Pt says:

    Hi
    Nifty spot at 10768
    Nifty 10700 pe @ 98
    Nifty 10700 ce @ 135

    Nifty 10500 pe @45
    Nifty 10850 [email protected]

    If I short 10700 straddle , buy 10500 pe and buy 10850 ce

    Is it mean , 98+135-45-60=133 confirmed profit?

    • Karthik Rangappa says:

      In you want a short straddle at 10700, you need to sell both CE & PE at 10700. So net debit of 233 i.e 98+135.

  26. Pradeep says:

    Hi Kartik,

    Thanks for knowledge sharing.

    I was trying to understand using futures for hedging against price movement in case of short straddle, keeping it Delta neutral. Future has fixed Delta & does not have any Theta hence no Theta decay gain. Does it mean purpose of buying/selling of Future is only to hedge the strategy against price movement?

    Loss arising due to price movement of futures, is the price you pay for safeguarding your position. Your maximum profit received as total premium, will be lessened by the loss in future.

    It does mean that you should come out of the strategy when the loss due to future hedging is becoming more than the premium received.

    Is my above understanding correct?

    Rgds

    • Pradeep says:

      Sorry for typo in name – It should be Karthik.

    • Karthik Rangappa says:

      Yes, futures have no theta and its delta is fixed at 1. In case of a short straddle, you are already delta neutral (of course the overall delta of the position should be 0). In case its not, then you can adjust the options position to ensure you are net 0 delta. Adding a long future will heavily skew the short straddle position. Its best you use options itself to maintain delta neutrality.

  27. Sandeep says:

    Sir I am very much interested in stock market. I don’t have much money to go and take classes so just wanted to confirm by going through with all your Modules will it help to know each details for trading

    • Karthik Rangappa says:

      Yes, Sandeep. Go ahead and make complete use of the content available freely for you here. I’m quite sure you’d feel confident dealing with markets after reading through Varsity. Happy learning!

  28. Adarshdeep Singh says:

    Hi Karthik,

    Is there any way we can get historical IV data?

    Regards,
    Adarsh.

  29. yesh says:

    what does “10 percent interest rate is applied while computing implied volatility means.
    Thanks

    • Karthik Rangappa says:

      The input for the risk free rate is taken as 10%. Guess this is how NSE (used) to compute. Need to check if there is a change in this.

  30. thambidurai says:

    Everything is fine but the XL link provided above for download is representing Long Straddle, not Short Straddle.

  31. Santhosh says:

    I am trying to use short straddle targeting the days before expiry date. Since it is a short straddle, I wish the stock price remains within the range. However, if the market starts moving in one direction, suppose in upward direction. I buy equities in cash to make the trade delta neutral (not futures as they are to be traded in lots and I may not be able to adjust the delta to exact zero). So if the stock moves further up, I make profit in equities which will offset loss in option. But my profit is reserved. If it reverses, I make profit in options which offset the loss in equity. But I may have to loose my profit in this case. I can encash the theta decay. vega is not a problem as it tends to decrease as it approaches towards expiry. That means to say that there is no way I make loss. I can never loose money. But that is not possible. So what is the catch? what are the cons in this type of trade except that we need more capital keep the delta neutral?

    • Karthik Rangappa says:

      Santhosh, with a short straddle, you have 2 legs – short PUt and short call. Your long equity offsets the short call, what about the short put position? That will remain unhedged.

      • Santhosh says:

        Yes sir. I have taken only one example of price going up. If price goes down, then to hedge short put option, I may short equities on intraday basis as I can even have some leverage (or short future also if I can adjust delta). Leave the untouched short call to make profit. So, how do I loose money? Of course, I may loose some money to the extent of gamma (as the delta itself changes with the price. ) but I may keep on adjusting deltas by buying or selling the equities as the price moves to ensure my principle. I am a newbie in option trading, so I want to make sure of risk before I start putting the money. I am not sure about practical application of these type of adjustments. So how exactly do I loose money? Please let me know where can I go wrong…

        • Karthik Rangappa says:

          Santhosh, the biggest gains/loss happens at the open, most number of days. So shorting spot for intraday may not work. You will have to short futures and carry forward the position. What you are suggesting is a form of delta hedging. The biggest problem with this is that you will lose money in terms of transactions. On paper, it looks good but you really need to execute this once to understand how it behaves.

  32. Chander B says:

    Dear Karthik,

    Lets say that I enter into Short Straddle or Short Strangle as delta neutral strategy. During the course of the day if price moves in any direction, my delta changes ..To hedge it I Short/LongFutures..Even after hedging it the price varies, I may have to again short more calls/puts or Futures. My question is till how long one should keep on adjusting the positions? Is it necessary that delta must be zero only or delta of 0.3 is acceptable? When one should call quits and exit from the strategy?

    Regards

    • Karthik Rangappa says:

      I understand your concern, Chander. I used to face the exact same problem back in the days. I then switched to adjusting the position at the open of the day (based on the previous day’s close) and this started giving me better results. Maybe you can check this.

  33. Chander B says:

    Dear Karthik,

    Many thanks for quick revert on my above query.
    It is often said that one should Short Calls/Puts when the volatility is high and go long when Volatility is low..I assume it means Implied Volatility (IV). Now my question is how do we judge whether the volatility is really high or low? Against what should we compare the IV? I assume that IV to be considered should be of ATM strike..Pls confirm.

    Regards,
    Chander

    • Karthik Rangappa says:

      You can compare the current IV with historical volatility to gauge where the volatility is. Of course, this is not a very clean technique to figure out where the current day’s volatility stands at, but this works.

  34. Vishal says:

    Hi Karthik,

    Can you please explain how volatility behaves in the series of events in timeline?

    1) No news as of yet
    2) News about results being declared (Let’s say 20 days from now)
    3) Last few days leading upto the result
    4) On the day of result
    5) Immediately after result is announced
    6) Days after result is announced

    I will take a guess, please correct me if i am wrong
    1) Lets say Volatility is some X & not worry about it as we just need to understand relatively
    2) Increases
    3) Decreases
    4) Constant
    5) Constant (If news is as expected as market has discounted the news) / Increases if not met expectation / Increases if exceeded expectation
    6) Decreases if not constant in (5) else Constant

    By “Constant” i mean “almost flat” everywhere. And also if you can possibly give such a timeline for elections too assuming D-Street expects BJP to win.

    This is purely to understand the behaviour of IV

    • Karthik Rangappa says:

      Made few changes –
      1) Lets say Volatility is some X & not worry about it as we just need to understand relatively
      2) Increases
      3) Sharp increase
      4) Constant
      5) Cool off as the news and the outcome is known
      6) Decreases if not constant in (5) else Constant

  35. Shiv Gupta says:

    The excel sheet gives the P & L if the strategy is held till expiry.
    I wish to know what tools are available which will track the position (P & L) of strategy at any given time after is executed so that we could decide that we should liquidate the position without waiting for expiry.

  36. Amlan Dutta says:

    Hi Karthik,

    I have a doubt. If I initiate a short strangle position at the start of the day and if I exit the same at the end of day or any time on the same day, what will be my p&l. Will it be based on the underlying or based on the movement of the premiums I paid. Please help me.

  37. Santhosh says:

    Suppose I am expecting for sure that SBI share to be within 270 to 300 by the end of this month expiry which is trading around 285. But, being conservative I create a short straddle of 260 PE and 320 CE.
    However, if stock starts moving up and reaches 300. Then, I buy back 270 PE and using same amount, I buy 315 CE. The price of 315 CE will be higher but I am insulated against further rise and loss will be minimum. Also investment needed to buy option is lesser than it is for futures. What do you feel about this strategy?

    • Santhosh says:

      *Sorry. It meant to say short STRANGLE

    • Karthik Rangappa says:

      If you are really sure about the range, then you can certainly do this Santhosh. However, I think you should look at short strangle and not short straddle.

      • Santhosh says:

        Actually, there is no way to be really sure about the range. I just see there are huge numbers of open interest standing at these points nearly 5 million on each strikes i.e at 270 and 300. I am not seeing any reason for any huge moves before expiry and stock is not really moving. Is that reason strong enough?

        • Karthik Rangappa says:

          Santhosh, it is a different thing if you are certain about the range. However, it is better to always have an element of the margin of safety in your trades.

  38. Santhosh says:

    Generally short straddle or strangle gives better results in range bound markets. It is even bit easier to hedge our position by neutralising the delta and thus offers relatively less risk. However, the biggest risk is some unexpected news which happens overnight. It would not have been captured in IV also. The price of a stock may open even at 10% high or low. Even stoploss wont save u. Of course it doesn’t happen always. But when it happens, it takes away all the small profits we made in several previous trades along with some investment too. Eating like sparrow and shitting like elephant. Like what happened with SBIN in oct2017. So how do we address this in case of short straddle or strangle?

    • Karthik Rangappa says:

      Completely agree, Santhosh. This is true with writing deep out of the money options as well. The several small profits one makes can be wiped out in one black swan event. In this context, I’d suggest you read Anti Fragile, by Taleb.

  39. Binesh says:

    a. In the above case study, Puts drop value faster than Calls..Is it because volatility has a larger effect on Puts than Calls?
    b. Do you always prefer Option strategies to minimize risk. Do you ever consider trading – Naked Calls, Puts? 🙂

  40. Narender says:

    Good Morning,

    Suppose I execute Short Straddle at ATM and simultaneously go long on both Call and Put at lower and Upper Breakeven points.

    Will I be expected to loose money except for calculation errors I mean insignificant losses,

    Limited profit in case market remains within range.

    Thanks

    • Karthik Rangappa says:

      You’r overall strategy breakeven will be very high, Narender. I’d suggest you put these numbers on excel and check the payoff and breakeven. You can improvise on the same excel used in this chapter actually.

  41. Mani says:

    Hello sir, I found that there are some many crashes in “stock market crashes in India wikipedia site”, is all the crashes very serious, keeping all these in mind how does one write strangles sir?

  42. Mani says:

    I tried varsity app it is very intuitive and nice.

    To make my short call option delta neutral I have hedged it with long futures sir, but in this case how to protect my position from gap openings sir, If I hedge gamma then I have to buy options which will be affected by theta decay.

    Also how to select strikes for writing calls sir?

    • Karthik Rangappa says:

      Glad you did, Mani. Please don’t forget to rate the app 🙂

      The gap up opening should be taken care of by the futures itself. To select strikes, I’d suggest you look at the standard deviation, add 2SD to CMP and look for strikes.

      • Mani says:

        rated sir😀

        When should I adjust my position, how much of delta variation can be allowed in a delta neutral position sir?

        • Karthik Rangappa says:

          Thanks, Mani!

          Adjust the delta if your position has transitioned from ATM to deep OTM/ITM.

          • Mani says:

            ok sir, in a nifty delta neutral position with long fut and short CE, if the underlying does down then we will lose more money in long futures position than short CE positions isn’t it sir? how to manage such a scenario?

          • Karthik Rangappa says:

            That’s probably correct. Unfortunately, no hedge there, unless you have a far OTM put.

          • Mani says:

            I don’t understand “unless you have a far OTM put” statement sir, but if I have a far OTM put then that will also lose money if the underlying goes down, isn’t it sir?

          • Karthik Rangappa says:

            No Mani, if you have a PE, you make money when the underlying goes down.

          • Mani says:

            oh k sir!! I thought of short PE position but I think you are implying long PE position.

          • Karthik Rangappa says:

            Yup, long PE.

          • Mani says:

            I think I am getting the idea sir, how to select strikes for long PE sir? should I use mid or far expiry so that theta won’t affect it? also I have to make sure that overall position is delta neutral?

          • Karthik Rangappa says:

            This depends on time again. If this is close to expiry, you may want to consider ATM or close to ATM strikes. If there is more time to expiry, then slightly OTM will also do.

          • Mani says:

            Hello sir, I need your help again 🙂 . To create a delta neutral position with long fut, short CE and long PE I created two linear equations one for delta and another for theta, for different PE and CE strikes with respective delta’s and theta’s, I got number of solutions in this method, problem is how to select one solution? also here I assuming the theta randomly, is there any other way to do it?

            overall is the above way correct? is there a book that explores the concept deeper?

          • Karthik Rangappa says:

            I’d suggest you read Sheldon Natenberg’s book on Option Pricing. At any point, look at just the Delta.

          • Mani says:

            ok sir, I will read it.

          • Karthik Rangappa says:

            Sure.

  43. Lee Chen says:

    Hello,
    I like your short straddle strategy. That is also what I mostly use for my trades.

    I have a question. When you see clearly the moving direction of an underlying stocks (up or down), do you still use delta neural strategy? Have you ever tried to use delta positive strategy, which would be in favor of the moving direction of the underlying stock? I know it could be risky if the undering stock moves in the opposite direction. However, if the moving direction intraday is quite obvious, this delta positive strategy will result in higher profits, in addition to the time decay. Of course, you can always use the dynamic strategy to adjust your delta value. Do you agree?

    If you have tried this positive strategy, what is the sum delta value you would leave as positive? 0.2, 0.3 or else per pair of option? Taking into consideration of the margin requirement of selling options, we may need the sum delta value bigger than a certain value. Or the paper profits could be lower than just buying the equivelent stocks with the same amount of margin.

    I hope I make myself understood. Thanks for your time and considerations!

    • Karthik Rangappa says:

      I agree with you, if you are certain about the direction, then a naked strategy or delta +ve helps in boosting the profits. But then, it carries the risk of higher losses. So this really depends on your risk appetite.

      The extent of delta positive also depends on your risk appetite…I’d probably stick to under 0.5.

  44. Praveen Kumar says:

    Dear Karthik, today I find an unusual thing while trading.
    I shorted Nifty 11600 CE @ 3.

    At 3 27 PM NIFTY spot was trading at 11603.8

    But that NIFTY 11600 CE was trading at 0.05.

    How this can be possible. When Nifty spot was at 11603.8 then Nifty 11600 must be ITM.
    AS it is a CE so due to no time value and only intrinsic value the price should be 11603.8-11600= 3.8

    But being in ITM how it is trading at 0.05?

    Can you throw some light on this matter.

    Note- I took trade of Nifty weekly expiry. So that 11600 CE was of 11th April expiry

    • Karthik Rangappa says:

      Praveen, although the 11600CE was ITM by 3.8, but it was trading at 0.05 for two reasons –

      1) You are looking at [email protected]:27, but remember the settlement is based on the last 30mins average. I think Nifty settled under 11600 today.
      2) Even if the above was not true… let’s say the market’s average was trading at 11603, then the STT would kick in and you’s end up paying more STT than the actual profit.

  45. Praveen Sharma says:

    Hello Karthik

    I would like to understand option strategy adjustments method.

    • Karthik Rangappa says:

      By adjustment strategy, I guess you are talking about keeping the strategy delta neutral?

      • Praveen Sharma says:

        Yes ,
        but explain with an example.

        I had following trade on nifty april expiry
        11000 PE SOLD @ 296.8
        11000 CE SOLD @ 166.15
        11500 PE SOLD @ 179
        11500 CE SOLD @ 275

        Here my view was nifty would not close above 11800, but since it was a long way to expiry and nifty had reached 11800 my position was in loss, I could not figure out how to adjust the trade and hold it till expiry

        • Karthik Rangappa says:

          Praveen, for 4 leg option strategies, you need to use a tool like Excel to visualize your P&L and breakeven point. I would suggest you use the excel provided in the chapter as a template and input the data to see how this pans out.

          • Praveen Sharma says:

            Hello Karthik
            Thanks for your guidence.

            as per you ‘Now here is something for you to think about – When you initiate a straddle you are obviously delta neutral. But as the markets move, will your position still remain delta neutral? If yes, why do you think so? If no, then is there a way to keep the position delta neutral?

            If you can build your thoughts around these points, then I can guarantee you that your options knowledge is far greater than 90% of the market participants. To answer these simple questions, you will need to step a little deeper and get into 2nd level of thinking.’

            Karthik can you please guide little bit on this 2nd level of thinking.

          • Karthik Rangappa says:

            Praveen, this is quite simple.

            Assume you set up a straddle with ATM CE and PE options. The delta here would be 0.5 for CE and -0.5 for PE. Net Delta would be 0. Now assume after you set up, the market moves, now based on this move, the delta values also change…say something like 0.65 for CE and -0.4 for PE, so the net delta would be +0.15, which means the overall position is no longer delta neutral.

            This is what I was trying to convey.

          • Praveen Sharma says:

            Hello Karthik

            Thanks a lot.
            Will keep asking for your guidence.
            Take care

          • Karthik Rangappa says:

            Most welcome, Praveen.

  46. Rahul says:

    Karthik sir how to find the combined net break even points of two short straddles .

  47. Ananth Gopal says:

    Hello Karthik,

    I want to trade short straddle today, where bank nifty spot price is at Rs. 31450/-

    1. Short ATM 31400 CE @ Rs. 314.20/-
    2. Short ATM 31400 PE @ Rs. 218/-

    The credit that I would have received is Rs. 532.20/-. Considering the upper breakeven point would be 31900 and the lower breakeven point would be 30900, I understand if the spot price moves beyond these prices then I will be in loss, now to cover up this, what if my strategy is like this (4 Leg strategy)

    1. Short ATM 31400 CE @ Rs. 314.20/-
    2. Short ATM 31400 PE @ Rs. 218/-
    3. Long OTM 31900 CE @ Rs. 112.15/-
    4. Long OTM 30900 CE @ Rs. 75.5/-

    So in this case I would receive the credit of Rs. 344.55/- (314.20+218-112.15-75.5).

    1. I would like to know if this strategy works in my favor
    2. What will be the P&L look like.
    3. Also would request you to please share the excel sheet for the above 4 leg spread.

    Awaiting for your reply.

    Thanks & Regards
    Ananth Gopal

    • Ananth Gopal says:

      Hello Karthik,

      Sorry typo error

      1. Short ATM 31400 CE @ Rs. 314.20/-
      2. Short ATM 31400 PE @ Rs. 218/-
      3. Long OTM 31900 CE @ Rs. 112.15/-
      4. Long OTM 30900 PE @ Rs. 75.5/-

      Awaiting for your reply.

    • Karthik Rangappa says:

      Ananth, by adding the additional legs, you are protecting yourself from the unlimited risk associated with the short straddle. The PE protects you on the downside and the CE on the upside. You can check the payoff here – https://web.sensibull.com/builder

  48. Srikrishna Rowthu says:

    Hi Karthik,

    These days when I open varsity, I am being redirected to other webpages.

    I was in a doubt that some redirection is happening somehow, may be in my system or mobile.

    But now, when I opened in a different system, this was redirected to some website and immediately , the site wasn’t opened and antivirus promoted , Web Attack.

    So, I think there is some virus (or) some redirection to some affected urls is being happened.
    Kindly try to resolve this issue.

    Thanks
    Srikrishna

    • Karthik Rangappa says:

      Hey, thanks for bringing this to our notice. Maybe your system is compromised? I will double check with our tech team as well. Thanks.

      • Srikrishna Rowthu says:

        Hi Karthik,

        Now, the issue seems to be resolved. I don’t see redirection happening to other url’s now.

        Earlier, I don’t think so my system was compromised, since I was checking in one of the secure systems where there is hardly any chance of being compromised. But , right now, the issue looks that it is resolved. Thankyou.

        Thanks
        Srikrishna

  49. Straddle chart says:

    Dear Sir,

    Can u provide live chart for customized straddle and strangle chart for Nifty BankNifty weekly contract. pls help

    Paresh

  50. Satya says:

    Hi Karthik,

    Nifty SPOT on Aug 28-2019 at 1.55 PM is 10994
    11000 CE SEP is at 207
    11000 PE SEP is at 172
    Though 11000 PE SEP is slightly ITM, but premium of CE is high. Does it indicate anything bullish as CE Premium is high?
    If we consider both are At the Money options, why CE premium is high, can we draw any useful information from this?
    Thanks
    Satya.

    • Karthik Rangappa says:

      Yeah, this is a reflection of the demand for calls, which further implies that the market expects a bounce in this expiry.

  51. Suvajit says:

    Hello Karthik,

    Again back to your learning material. I always find them really helpful.

    I have a simple (may be dumb) question for you.

    For a Long Straddle: IV we should choose “Low” and vise versa for Short Straddle.

    Can you please give me some idea of may be “Nifty” what should I consider as “Low” & “High” IV value (eg. 15% & 40%) when considering a straddle?

    Regards,
    Suvajit

  52. Suvajit says:

    Thanks Karthik.

    Just one more query, is India VIX same as Nifty IV? Where can I get this data in order to make some calculations?

    Suvajit

    • Karthik Rangappa says:

      Nope, they both are different, Suvajit. Nifty IV represents the implied volatility of a strike you are looking at, while the India VIX can be taken as an implied volatility proxy for the whole market.

  53. Suvajit says:

    Thanks Karthik!! Yes it makes sense.

  54. AUSTIN D says:

    Have seen the reply of you to Chander : I understand your concern, Chander. I used to face the exact same problem back in the days. I then switched to adjusting the position at the open of the day (based on the previous day’s close) and this started giving me better results. Maybe you can check this.

    Karthik anna kindly clarify the same atleast with two examples, hope you will reply
    🙂

    • Karthik Rangappa says:

      Austin, when you short a straddle or strangle, you are essentially delta natural. For example, you sell ATM CE and PE, the delta of these positions will be +0.5 and -0.5 respectively. When you add the positions up, you will get a delta of 0, which makes the overall position delta zero.

      Now, assume the market moves 2% after you initiate the position. In such a case, the CE would gain delta, let us say it becomes +0.75 and now the PE will lose its delta, so lets say it is -0.45. The overall delta of the position is – +0.75-0.45 = +0.3, making it a delta positive position. Now, if you want to bring this back to delta-neutral, you will have to short a slightly OTM PE which has a delta of -0.3, this will make it delta neutral.

      This is what is called as ‘adjusting for delta’, which was being discussed.

  55. AUSTIN D says:

    ‘I then switched to adjusting the position at the open of the day (based on the previous day’s close) and this started giving me better results’
    I just want to know about your style of trading with futures
    For eg you initiated short stangle when Nifty is at 11010 in the morning, writing 10900PE (eg 5 lots) and 11100ce (5 lots) and at evening nifty is at 10920. So will you be adjusting the delta on the same day while nifty is going down or next day’s opening using futures, or will you be exiting the put option written?

    • Karthik Rangappa says:

      This depends on the variation the delta from neutral position. If it is more than 0.25 or -0.25, and if it is viable (both time and margin availability) to adjust by close, I’d, else I’d adjust the position the next day at open.

  56. AUSTIN D says:

    Thanks Karthik bro for your quick reply. Wholehearted thanks and wishes to Zerodha team for the spirit to make retail investors profitable. :*
    Hope you will shortly publishing delta hedging chapters 🙂

  57. AUSTIN D says:

    As a mentor could you please say your trading P&L on 20/sep/2019 and your startegies on the particular day 😀

    • Karthik Rangappa says:

      There was no strategy for that particular day, Austin. No one knew this was coming. However, I was invested in stocks and those bounced 🙂

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