Hedging a Short Straddle?
Instead of writing an uncovered call and put at the same strike, what if you were to do a buy-write call and a put at the same strike... all at-the-money?
Your losses would still be unlimited on the up side but all unrealized and your losses on the down side would me limited to the losses of the underlying as you would simply end up owning the underlying... what am I missing?
Comment on "Hedging a Short Straddle".
TSO Reply: Hi Rich. If I’ve understood you correctly, you are asking how to hedge a Short Straddle position. You are trying to hedge by using a buy-write (Covered Calls) strategy combined with a Short Put position. Let me know if this is not your query and I’ll answer it again.
If you look at the risk profile (graph) of both Covered Calls and Short Put, you will notice that both strategies share the same risk profile!
This two strategies are basically a bullish to neutral strategy. They have unlimited risk to the downside and limited reward to the upside. As such, if your concern is to hedge a a Short Straddle position, your combination of strategies will still leave your downside risk exposed.
An alternative strategy that can hedge both the upside and downside risk of a Short Straddle position is to employ a Long Iron Butterfly strategy.
This is a sideway strategy and is typically used to hedge a Short Straddle position at the expense of a lower profit.
Choose your strategies according to your outlook of the underlying stocks. Once you have analysed the probability of the stock overall direction, trade using the correct option strategies applicable to the stocks.
Have many profitable trades ahead!