A Covered Straddle is an option strategy wherein, the investor who owns a security, sells equal number of puts and calls of the same underlying, same expiration and same strike price.
When to use this strategy?
Such a strategy is entered into when the investor is bullish on the underlying security for the long term but has a short term neutral view on the asset.
How to build the strategy?
This strategy has three legs:
Leg 1 – Buy the underlying security, quantity being equivalent to the lot size of the options contract.
Leg 2 – Sell 1 ATM Call
Leg 3 – Sell 1 ATM Put
Credit Spread/Debit Spread
This is a Credit Spread Strategy.
The profit potential of this strategy is limited.
When is this strategy profitable?
The maximum gain for this strategy is reached when the underlying security price is above the strike price of the call option sold.
The investor faces unlimited risk in this strategy.
When is this strategy unprofitable?
The investor stands to make large losses if the underlying security price falls drastically below the purchase price of the underlying security.
In such a scenario, the investor looses on both, the underlying security as well as the put option sold.