Covered Straddle Explained: Definition, Mechanics, and Real-Life Examples

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What Exactly Is a Covered Straddle?

A covered straddle is an advanced options trading approach where an investor writes both call and put options on a stock they already own, aiming to benefit from upward price trends. This strategy involves shorting an equal number of calls and puts that share the same strike price and expiration date.

Understanding How Covered Straddles Operate

Designed to potentially profit from bullish expectations on an underlying asset, covered straddles are typically executed on highly traded stocks. The strategy entails selling both a call and a put option at the same strike price while holding the underlying stock, effectively creating a short straddle position backed by ownership of the asset.

Much like a covered call—where an investor sells calls against shares they own—a covered straddle extends this by also selling puts at the same strike price. However, because the put side is uncovered, this strategy carries the risk of significant losses if the stock price falls sharply.

Key Insights

• A covered straddle combines short call and put options at the same strike price with ownership of the underlying shares.
• It is typically employed by investors expecting minimal price movement before option expiration.
• Unlike a fully covered strategy, only the call option is protected by the underlying shares, leaving the put position exposed.

Constructing a Covered Straddle: A Practical Example

Implementing a covered straddle requires owning the underlying security associated with the options. Since most option contracts represent 100 shares, investors usually need at least 100 shares to start.

For example, an investor owns 100 shares priced at $100 each. They then sell both call and put options at the $100 strike price with the same expiration, generating an initial net credit from these sales.

Step 1: Hold 100 shares valued at $100 per share.

Step 2: Sell a call option at $3.25 and a put option at $3.15, resulting in a total credit of $6.40.

If the stock price remains unchanged, the investor retains the $6.40 premium. Gains and losses offset each other as the price moves, capping the maximum profit at $6.40.

However, if the stock price drops, losses increase significantly. For each $1 decline, the combined position loses $2, meaning losses begin once the stock falls below approximately $96.80.

Important Considerations for Covered Straddles

While termed "covered," this strategy only truly covers the call option since the put is left "naked"—exposing the investor to potential assignment and the obligation to purchase shares at the strike price.

Though profits are limited to the premiums collected, the risk of substantial losses exists if the stock price plummets well below the strike price by expiration. If the underlying remains stable, the investor benefits by collecting premiums.

Both institutional and retail traders can employ covered straddle strategies to generate income from options, provided they have the necessary permissions on margin and options trading platforms.

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