The Short Put Synthetic Straddle involves selling puts and counteracting them with a Short Stock position.
To create the Short Straddle shape, we have to sell twice the number of puts.
So for every 100 shares we sell, we have to sell two put contracts, which represent 200 shares of the stock.
This strategy creates a large net credit in our accounts and as such can be considered an income strategy.
Sell the stock (if trading U.S. stocks, sell 50 shares for every put contract you buy).
Sell two ATM Puts per 100 shares you buy.
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 Put 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 Put 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
This is a net credit trade because you are selling both the stock and the put options, thereby receiving money into your account.
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 put position.
Appropriate Time Period to Trade
We Require Shorter Period of Time to Expiration.
Breakeven Down [Stock price – (2 * put premium)]
Breakeven Up [Stock price + (2 * put premium)] – [2 * (stock price -put strike)]
Exiting the Trade - Short Put Synthetic Straddle
Exiting the Position
If the stock remains below the put 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 puts.
Alternatively, you can set up another strategy involving being short in the stock.
Mitigating a Loss
If the stock moves explosively downwards before expiration, you will be exercised, meaning that you will have to deliver double the amount of stock you shorted.
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 consider buying back the stock.
You will then be short in two puts, which you may have to buy back or hedge in order to avoid an unlimited risk position.
If the stock hits the lower price band, triggering your stop loss, then you should buy back your sold puts.
Advantages and Disadvantages
Advantages
Profit from a range bound stock.
No capital outlay.
Substantial net credit received.
Disadvantages
Uncapped risk if the stock moves in either direction.
Capped reward.
High-risk strategy, not for novices or intermediates.
