A trading related question?

[Eddie]

It's late, so my brain is not thinking!

So what is the RISK of holding short position in both a put and call on the same underlying?
Where the price movement of those two offset each other , but the time decay in both really works for the holder of the short?

 

[Erica]

Apologies in advance if this isn't mathmatical enough, I'm giving you this response as a former trader. If you go short the straddle(sell call and sell put) you collect premium upfront which decreases over time at expiration, value is zero and you win. The beauty of theta.

However, you have assignment risk. If underlying moves above strike in either direction by more than the value of the premium, you lose. This is the beauty of gamma, inverse of theta.

Also, assuming you are hedged(ie delta neutral) you still have volatility risk, also known as vega. If vega increases, all options become more expensive and your hedge will no longer be appropriate.

In short, selling options is great if vol is high and the market flatlines going forward. This is not a very likely scenario as financial markets tends to exhibit positive autocorrelation over successive time periods.

Hope this is helpful

 

[Eddie]

Hi Erica, you covered just about all the Greeks in one shot , beauty!
Cheers.