Whats a straddle?
Its a strategy whereby a trader sells a Nifty call and put of the same strike and receives a premium from the buyer.
Why does one sell a straddle?
You sell a straddle on the assumption that an underlier, in this case Nifty, would not rise above or below a certain level, which will enable you to pocket almost all or the entire premium paid by the buyer. The buyer buys a straddle as he expects there will be a sharp movement, either up or down, which will help him earn a profit. However, in most cases the seller beats the buyer as he charges a hefty premium on the straddle. In certain cases when the movement is very strong, though, the seller can end up incurring heavy losses.
An illustration…
Assume a seller feels the Nifty will not rise above or below a certain level by expiry on July 25 — there are weekly expiry contracts on Nifty too. He sells an 11,800 straddle (call and put) at Fridays closing rate of Rs 139 a share (75 shares make a lot) for a call and Rs 128 for a put, or a combined Rs 267. His upper break-even point above which he makes losses is 12,067 and the lower break-even point for losses is 11,533. He makes a maximum profit of Rs 267 if the Nifty expires at 11,800. Each point above or below 11,800 reduces the profit until the UBEP or LBEP. He thus expects the Nifty to trade within an 11,533-12,067 range.
What happens if the Nifty expires at 11,900 or 11,700?
The 11,800 call is in the Read More – Source
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ET Markets
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