Inverted Straddle Options Strategy Explained
Discover what an inverted straddle is, how it differs from a regular straddle, and what are the dangers of using this adjustment technique.
Understanding an Inverted Straddle
A straddle is an options strategy that involves selling two options with the same strike price and expiration date, one call and one put. The idea behind a straddle is to profit from a flat movement in the underlying stock while collecting premium from both options. A straddle is a neutral or non-directional strategy since it does not require a specific direction for the stock to move.
However, the stock may sometimes move too far in one direction, making one of the options go deep in-the-money (ITM) and increase in value. This can result in a large loss for the straddle seller, and they may want to adjust their position.
One way to adjust a losing straddle is to invert it, which means rolling the untested side of the straddle. This way, the trader can neutralize their delta, reducing directional risk.
Inverted Strangle Risk Diagram on tastytrade
What is an Inverted Straddle?
An inverted straddle is not a standalone option strategy but rather an adjustment to an existing straddle position. By definition, a straddle must have the same strike price for both options so it cannot be inverted. However, traders often refer to an inverted position as an inverted straddle, even though it technically becomes an inverted strangle.
A strangle is similar to a straddle, except it involves selling two options with different strike prices, usually, one out-of-the-money (OTM) call and one OTM put. A strangle doesn’t allow you to collect as much premium as a straddle, but it provides a wider profit range.
Converting a Short Straddle to an Inverted Straddle
To convert a short straddle into an inverted straddle, traders will generally roll the untested side. For example, if you sold a straddle on SPY at a $400 strike price, and it moved up to $410, the put will be in profit and untested, while the call will likely be marking at a loss.
To invert the straddle, you would buy to close the short put at $400 and sell to open a new one with a higher strike price, say $405. This will invert the straddle and turn it into an inverted strangle with a short call at $400 and a short put at $405.
The benefit of this adjustment is that it reduces your delta exposure and increases your credit received. By rolling up the put, you are reducing your negative delta on the put side and increasing your positive delta on the call side.
This means that your position will become less sensitive to further increases in the stock price. Additionally, by rolling to a higher strike put, you will collect more premium than you paid to close the lower strike put. This increases your overall credit received and extends your breakeven point.
Dangers of the Inverted Straddle Adjustment
While inverting a straddle may seem like a good idea in the moment, it can easily backfire. For example, if your short call gets tested and you roll your put up, the stock could easily drop and start testing your new short put, putting you in a worse position than before. Therefore, you must fully understand the risks involved when inverting your straddle.
Another risk of inverting a straddle is that it reduces your probability of profit. You will have a decently sized profit zone when selling a regular straddle.
However, an inverted straddle has a lower probability of profit because you need the stock to stay within a narrower range since your strikes are inverted.
How to Learn More About Options Trading
Options trading can be fun and profitable if done correctly. However, it also requires a lot of knowledge, skill, and discipline.
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