Bottom Straddle (Put and Call, Writing method)
The Bottom Straddle is formed when trader writes put options and the same number of call options with the same strike price on the underlying asset.
Let us assume that the trader writes puts and calls with strike price K1. In this method, the trader will enjoy cash inflow from writing options, unlike the Top Straddle. The presumption is all options should expire on the same time.
(compute based on: options volatility 54%, risk free rate on options 10%, K $55, K1 $55, period 6 months, present value of initial cashflow neglected, equity)
Let us assume C1 be write price of call option with underlying strike price K1, P1 be write price of put option with underlying strike price K1. The assumed price of underlying asset is at K1.
Initial Cash Outlay = C1 + P1 (C1 > P1 )
|Underlying Price Range||Payoff from Short Call Option at K1 strike||Payoff from Short Put Option at K1 strike||Total Payoffs|
|ST ≤ K1||0||– (K1 – ST )||C1 + P1-(K1 – ST )|
|ST > K1||-(ST – K1)||0||C1 + P1– (ST – K1 )|
In the model of Bottom Straddle using cash inflow method, the trader has opinion that the underlying price will remain close to K1 so that there will be a profit.
The Bottom Straddle can be viewed as a profit capped trade as profit is limited to C1 + P1. Alternatively, the Bottom Straddle is a low reward high risk trade because loses are unlimited when price of underlying moves up; and loss up to price of underlying up less selling price of to a maximum of K1 if prices of underlying dropped.
This trade is a form of volatility trade as the stock price is not expected to move away from K1. There is another volatility trade that will yield greater returns with lower cash outflow. However, it will be a lower probability event because the expected volatility is required to be much higher than the Straddle.
(compute based on: options volatility 54%, risk free rate on options 10%, K $55, K1 $50, period 6 months, present value of initial cashflow neglected, equity)
(compute based on: options volatility 54%, risk free rate on options 10%, K $55, K1 $60, period 6 months, present value of initial cashflow neglected, equity)
Please also look at the Strangle.