How to Calculate Short Straddles and Combinations for the Series 7 Exam
The Series 7 will expect you to understand short positions. Short positions involve selling a call and a put with the same underlying stock. In straddles, the calls and puts have the same strike price and expiration month; with combinations, one of these values may differ.
A short straddle is selling a call and a put with the same underlying stock, the same strike price, and the same expiration month. An investor who is short a straddle is looking for stability. Because these investors are looking for a stock that’s not going to change too much in price, short straddles are considered a neutral position.
If the stock doesn’t move in price, these investors will be able to keep the premiums they received for selling the options. A short straddle may look like this:
Sell 1 GHI Oct 50 call at 9
Sell 1 GHI Oct 50 put at 2
In order to have a short straddle (or combination), you must have two sells.
A short combination involves selling a call and a put for the same underlying stock with a different strike price and/or expiration month. Similar to a short straddle, an investor who sells a combination has a neutral position and is looking for stability. The investor is hoping the securities don’t go in-the-money so the options are not exercised and she gets to keep the premiums received.
A short combination may look like this:
Sell 1 QRS Dec 60 call at 4
Sell 1 QRS Mar 55 put at 3
Fortunately, for both straddles and combinations, you can calculate the maximum gain and maximum loss by just placing the premiums in the options chart. No exercising is necessary. For instance, suppose an investor has the following ticket orders:
Sell 1 TUV Jul 45 call at 6
Sell 1 TUV Jul 40 put at 3
Here’s how you find the maximum potential loss and gain:
Find the investor’s maximum potential gain.
This problem involves a combination because the strike prices are different. However, if it were a straddle, you’d figure out the answer the same way. Place the premiums in the options chart. The investor sold the call for $600 (6 × 100 shares per option) and the put for $300 (3 × 100 shares per option).
The transactions are both sells, so they have to go in the Money In side of the options chart. Add the numbers, and you can see that the maximum that this investor can gain (if the options never go in-the-money) is the $900 ($600 + $300) in premiums that she received.
Determine the investor’s maximum potential loss.
With straddles and combinations, the premiums help you determine both the maximum potential gain and the maximum potential loss. After entering the premiums in the options chart, you may notice that the Money Out side of the chart is empty, so the investor’s maximum potential loss is unlimited.