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Short premium

Any position that is net short extrinsic value, so time decay helps and rising implied volatility hurts.

Short premium describes a stance rather than a specific trade. credit-spreads, iron-condors, short strangles and covered-calls all share the signature: positive theta, negative vega, negative gamma.

The characteristic P&L is many small wins and occasional large losses. That is not a flaw to be fixed; it is the shape of the payoff, and position sizing is the only real defence.

Example: an iron condor on XYZ collecting $1.10 with $3.90 of risk wins about 75% of the time in backtests. Seventy-five wins of $110 is $8,250; twenty-five losses of $390 is $9,750. A structure that wins three times out of four still loses money if the sizing and the credit are wrong.

Related: long-premium, theta, vega

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Payoff of an iron condor at expiryA flat profit plateau between the two sold strikes, falling away to a capped loss on each wing.Profit / loss per share0841001169095105110buy 90 putsell 105 callsell 95 putbuy 110 callMax profit 2 — the net creditMax loss 3Max loss 3Breakeven 93Breakeven 107Underlying price at expiry
Iron condor: payoff at expiry. Four strikes: the 2 credit is kept in full while the price finishes between 95 and 105, and is lost gradually outside the 93 and 107 breakevens. The bought 90 put and 110 call stop the loss at 3 on either wing.
How a position size is worked outAccount size, risk per trade and stop distance feed into one box giving the number of shares.ACCOUNT SIZE$25,000your capitalRISK PER TRADE1%of the accountSTOP DISTANCE$0.50entry to stopPOSITION SIZE500 sharesrisk budget: $25,000 × 1% = $250position size: $250 ÷ $0.50 = 500 shares
Working out a position size. Three numbers decide how big a trade is: the account, the share of it put at risk, and the distance from entry to stop. One percent of $25,000 is a $250 budget, and a $0.50 stop divides into that 500 times.

Educational only, not advice. Spotted an error? Post in Site Feedback.