The Short Strangle is a variation of the Short Straddle. It aims to increase the profitability of the trade for the option seller. The breakeven points are widened to achieve this. This necessitates significantly more change in the underlying stock/index. In exchange, the Call and Put option may be worthwhile to use. This method entails selling two options at the same time.
If used appropriately, a Short Strangle Strategy can be quite rewarding. It all comes down to the timing of options trades. A little out-of-the-money put is the first. A little out-of-the-money call is the second option. The underlying stock and expiration date for both options should be the same. When opposed to a Short Straddle, this usually means the seller receives less net credit.
This is because both alternatives have been sold. The breakeven points, on the other hand, have been widened. For the Call and Put to be worth executing, the underlying stock must move sufficiently. The seller of the Strangle gets to keep the premium if the underlying stock does not move substantially.
There are mainly two types of strangles, and they are distinguished below:
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Long Strangle |
Short Strangle |
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It is the more popular technique that involves purchasing both an out-of-the-money call and an out-of-the-money put option at the same time. The strike price of the call option is greater than the current market price of the underlying asset, while the strike price of the put option is lower. As the call option has theoretically unlimited upside if the underlying asset grows in price, and the put option can benefit if the underlying asset falls in price, this approach has high-profit potential. The trade's risk is limited to the difference between the two options' premiums. |
A short strangle involves selling an out-of-the-money put and an out-of-the-money call at the same time. This technique is a safe bet with little profit potential. When the prices of the underlying stocks trade in a small range between the breakeven points, a short strangle makes money. The maximum gains are equal to the difference between the net premiums collected for writing the two options and the trading fees. |
Here are the major components of implementing the short strangle option strategy:
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1. Overview of Short Strangle Option: |
The Strategy aims at succeeding if the stock price and volatility stay steady during the life of the options. |
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2. Variations of the Strategy: |
The Strategy varies to a straddle when the call strike is above the put strike; as a general rule - both the call and the put are out of the money and close to central from the underlying when initiated. |
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3. Profit and Loss from the Strategy: |
The maximum loss is unlimited, and maximum loss occurs only if the stock goes to infinity, and a very substantial loss could happen if the stock becomes worthless. In both of the cases, the loss is reduced by the amount of premium that is received selling the options. The maximum gain is limited, and the gain only occurs if the stock stays between the strike prices. In this case, both options will expire worthlessly, and the investor will pocket the premium that is received for selling the option. |
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4. Breakeven of the Strategy: |
This strategy breaks even if, at the expiration, the price of the stock is above the call strike price or the below the put strike price by the amount of premium received initially. At either of the levels, one option's intrinsic value would be equal to the premium received for selling both the options, while the other option would be expiring worthless. |
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5. Time Decay: |
The passage of time, all of the other things equal, would have a positive impact on the Strategy. Each day that passes without a move in the stock price brings both of the options one day closer to being expired. |
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6. Volatility: |
An increase in the implied volatility, all of the other things equal, would have a very negative impact on the Strategy. Even when the stock price holds steady - a quick rise in the implied volatility will push the value of both options and force the investor to pay the additional margin in order to maintain the position. |
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7. Assignment Risk: |
Early assignment, while possible, would generally occur for a call only when the stock goes ex-dividend or for a put when it goes deep in the money. |
Since the short strangle option strategy carries an unlimited risk potential, it is critical for an options investor to keep the following in mind before initiating the position: