What is a bear straddle?

What is a bear straddle?

A Bear Straddle is another name for a short straddle, in which the investor writes (goes short) on both a call and a put, for the same strike price and expiration, on the same underlying stock.

A short straddle can be called a bearish position because the investor believes that the underlying will basically hibernate until expiration. As long as the price of the underlying remains close to the strike price, the investor can make a profit, with the maximum profit being the premium collected from the sale of the options which have expired worthless.

There is a large risk involved in short straddles, however. If an unforeseen occurrence causes the underlying security to experience a large price jump in either direction, the investor is at risk for unlimited losses. A short straddle position caused the drama that inspired the movie Rogue Trader with Ewin McGregor.

Nick Leeson was a young trader working with Barings, the second-largest bank in Britain, working without much oversight in their Singapore offices. He took up an overnight position with a large short straddle on the Nikkei. Normally this would be a relatively conservative position, especially compared to some of the other speculative tradings he had been doing, but an earthquake suddenly disrupted business and sent the Nikkei plummeting.

As he tried to recover lost money with increasingly risky positions, he racked up a total of around $1 Billion in losses and bankrupted Barings. A long straddle benefits from volatility, while a short straddle benefits from stagnancy and horizontal movement.