Short Straddle: Income Generation, Maximum Profit, and Unlimited Risk
An options trader believes that Global Logistics (GL) will trade in a tight horizontal range around $45 following its analyst day. The trader writes 1 GL Sep 45 Call at $3.25 and writes 1 GL Sep 45 Put at $2.75. What is the trader's maximum potential profit and maximum potential loss?
A short straddle yields maximum profit equal to total premiums collected ($3.25 + $2.75 = $600), but carries UNLIMITED risk on the upside due to the short uncovered call.
Complete Analysis & Legal Rationale
Total premium collected = $3.25 + $2.75 = $6.00 per share ($600 total). This is the maximum profit, achieved if the stock closes exactly at the $45 strike at expiration, causing both options to expire worthless. However, because the trader wrote an uncovered (naked) call, the trader is exposed to UNLIMITED risk if the stock surges dramatically upward.
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:
Accurately states the $600 maximum premium collected and recognizes unlimited upside liability from the short naked call.
Omits the short put premium and assumes downside is the only risk.
Calculates maximum downside loss if stock falls to $0 ($45 - $6 = $39 per share), but ignores unlimited upside risk.
Inverts the positions of writer and holder.
Official Standard: Mandates disclosure of unlimited risk for short uncovered call positions.