A short straddle is a combination of writing uncovered calls (bearish) and writing uncovered puts (bullish), both with the same strike price and expiration. Together, they produce a position that predicts a narrow trading range for the underlying stock.
Before there were options, it was difficult for investors to profit directly from an accurate prediction that didn’t involve a steep rise or fall in the stock. The short straddle is an example of a strategy that does. By collecting two up-front premiums initially, the investor builds a larger margin of error, compared to writing just a call or a put option. However, the risks are substantial on the downside and unlimited on the upside, should a large move occur.
The investor may be able to reduce the chance of assignment by selecting a longer term to expiration, and by monitoring the underlying stock closely and being ready to take quick action. Still, no precaution can change the fundamentals: limited rewards for unlimited risk.
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