Options Trading Made Easy: Synthetic Short Put Straddle

You’ve got options, friends.
When it comes to initiating a synthetic short straddle, you can do it using either puts or calls. But in this installment of “Options Trading Made Easy,” we’re just focusing on the former. For those interested in knowing more about synthetic short call straddles, please have a look here.
We start first with how to make it.
A synthetic short put straddle is composed of two elements:

1. The short sale of 100 shares of the underlying security; and
2. The sale of two at-the-money puts.

When to Use It?

The strategy is best employed when traders expect a period of low volatility to ensue. It produces maximum profits when exactly that happens: the underlying expires precisely at the strike price of the at-the-money puts.
Maximum losses are a different story, though. Synthetic short put straddles are a limited profit, unlimited risk proposition. They could theoretically bankrupt the Rockefellers should the price of the underlying move sharply in either direction.
The example below will demonstrate exactly how it all works and provide you with one of the more common scenarios for implementing the strategy.

Above is a chart of coal producer Peabody Energy (NYSE: BTU) during a segment of its all-too-long bear market.
Let’s imagine it’s late January and your research indicates that Peabody is about to take a meaningful tumble. With the stock at $390, you short 100 shares (red circle), and presto! the shares start falling just as you expected.
But some 10 weeks later, with the trade up over 30%, you get the feeling that a temporary bottom is in. You don’t want to close the position outright – because you feel there’s more downside ahead – but you’d also like to profit from any sideways movement in the stock, if there were just some way to do so.
Your broker assures you that there is. He recommends you initiate a synthetic short put straddle, a strategy that offers a reasonable profit if the stock meanders in a tight range for the next eight weeks.
So you do it. With the stock crossing $300, you sell two May at-the-money puts for $4.50 each, for a total credit of $900 (blue circle). Break-even for the trade, therefore, is $309 on the upside and $291 below. If the stock moves beyond those parameters, you start to lose.
Nailed it!
As it turns out, the stock drifts for the next two months and closes at expiry at exactly $305 (black circle). The short puts expire out of the money and you pocket the full $900 premium. Your short stock is in a theoretical “loss” position of $500, since you initiated the trade at $300, so your total take is $400 ($900 – $500).
Indeed, that’s precisely what would have transpired had you initiated a regular short straddle at the $300 level. The short at-the-money put and call would have fetched you $4.50 each, giving you $900 of initial premium. At expiry, the short put would have been worthless, but the short call would have been in the money $5.00, producing a loss of $500. All told, you would have pocketed the same $400 ($900 – $500).
Best of luck!

You won’t find this anywhere else

You’ll never read about this powerful trading strategy in the Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.