The Short Call Synthetic Straddle involves selling calls and counteracting them with a long stock position.
To create the short straddle shape, we have to sell twice the number of calls.
So for every 100 shares we buy, we have to sell two call contracts, which represent 200 shares of the stock.
Instead of selling calls and puts together, we create the same risk profile by combining short calls or puts with a long or short position in the stock.
Buy the stock (if trading U.S. stocks, sell 50 shares for every call contract you buy).
Sell two ATM calls per 100 shares you sell.
If the current stock price isn’t near the nearest strike price, then it’s better to choose an OTM strike (higher than the current stock price).
Steps to Trading a Short Call Synthetic Straddle
Steps In
Try to ensure that the trend is range bound and identify clear areas of support and resistance.
Try to ensure that no news is coming out imminently for the stock.
Steps Out
Manage your position according to the rules defined in your Trading Plan.
Close the losing side by unraveling the relevant side if the stock breaks in either direction.
Unravel the entire trade if the position is profitable and you think news may emerge about the underlying stock.
Context-Short Call Synthetic Straddle
Outlook
With a Short Synthetic Straddle, your outlook is direction neutral
You are looking for no movement in the stock and reducing volatility.
Rationale
To execute a direction neutral trade where you expect the stock to be range bound and behave with reduced volatility.
Net Position
If you’re trading stocks, this is a net debit transaction because you are buying the stock and receiving only a fraction of that credit for the Short Call options.
Your maximum risk is uncapped if the stock moves explosively in either direction.
Your maximum reward is capped and occurs at the strike price.
Effect of Time Decay
Time decay is helpful to your Short Call position.
Appropriate Time Period to Trade
We want to combine safety with prudence on cost.
Breakeven Down = [Stock price – (call premium * 2)]
If the stock remains below the call strike, then the short options will expire worthless at expiration, and you will keep the premium.
You can then either sell the stock or re-create the position with next month’s sold calls.
Alternatively, you can set up another strategy involving being long in the stock.
Mitigating a Loss
Unravel the position as described previously.
If the stock moves explosively upwards before expiration, you will be exercised, meaning that you will have to deliver double the amount of stock you hold.
At the beginning of the trade, you will have predefined your stop loss areas.
If the stock hits the upper price band, triggering your stop loss, then you should buy back at least one of the calls.
If the stock hits the lower price band, triggering your stop loss, then you should sell the stock, provided that your account permits you to trade naked options.
Advantages and Disadvantages
Advantages
Profit from a range bound stock.
Disadvantages
Uncapped risk if the stock moves in either direction.
Capped reward.
Expensive trade because you have to buy the stock.
High-risk strategy, not for novices or intermediates.
