Short Straddle Maximum Profit and Risk Profile
An options trader sells 1 DEF Oct 75 Call at 5 and sells 1 DEF Oct 75 Put at 4 when DEF is at $75. What is the trader's maximum potential gain, maximum potential loss, and market attitude?
Short straddles collect combined premiums upfront ($900 max profit) and desire price neutrality; the naked short call creates UNLIMITED upside loss potential.
Complete Analysis & Legal Rationale
Writing a short straddle involves selling both a call and a put at the same strike ($75). Total credit collected = $5 + $4 = $9 per share ($900). Maximum gain is capped at this $900. Because the short call is uncovered, the writer faces unlimited upside risk if DEF skyrockets. Outlook is neutral.
Mathematical Step-by-Step Derivation
- Step 1: Total Premium Collected = $5 + $4 = $9 ($900 Max Gain).
- Step 2: Downside Max Loss = $75 strike - $9 credit = $66 ($6,600 at stock = $0).
- Step 3: Upside Max Loss = Unlimited due to uncovered short call.
- Obligation on exerciseUnlimited upside risk
- Short 75 Call+$500.00
- Short 75 Put+$400.00
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
Correctly identifies $900 max gain, unlimited risk, and neutral outlook.
Inverts buyer and seller payoff profiles.
Only looks at downside loss to zero and ignores unlimited upside call risk.
Omits put premium and misidentifies market sentiment.
Official Standard: Establishes highest margin tier for uncovered short straddles.