Short Strangle is one of the sideway strategies employed
in a low volatile stock. It usually involves selling Out of The Money
puts and calls options with the same expiration date and underlying
stock but different strike price.
Outlook: With this stock option trading strategy, your outlook is directional neutral.
You are expecting a drop in volatility or no movement of the underlying stock.
Risk and Reward
Maximum Reward :
Advantages and Disadvantages
Exiting the Trade
Short Strangle Example
Assumption: XYZ is trading at $75.75 a share on Mar 20X1. You are expecting share price of XYZ to fluctuate back and forth within a range. However you would like to have a higher probability of profitable trade compare to a short straddle strategy. In this case, you may consider to sell one Apr 20X1 $80 strike call at $2.80 and sell one Apr 20X1 $70 strike put at $2.90 to profit from the sideway movement of the stock. Note: commissions are NOT taken into account in the calculation.
Analysis of Short Strangle Example
= Unlimited beyond the upside and downside breakeven point of the underlying stock
= Limited to the Net Premium Collected
= ($2.80 + $2.90) * 100 = $570
= Strike Price Plus Net Premium Collected
= $80 + $5.70 = $85.70
= Strike Price Less Net Premium Collected
= $70 - $5.70 = $64.30
This is a simple adjustment to the Short Straddle strategy to give it a relatively higher probability to a profitable trade by selling Out of The Money options. It is the direct opposite of a Long Strangle and easy to understand. You just need to sell an equal number of puts and calls options with different strike price but same expiration date. Then you can make a profit when the stock fluctuates back and forth within a range.
The maximum profit occurs when the underlying stock is trading between the strike prices at expiration date (where both puts and calls options expire worthless). This option strategy can be executed at any combination of strike prices but is typically established mid point of strike price near At The Money option.
Try to ensure that the stock is trading range bound and identify clear areas of strong support and resistance. Ideally you are selling the options when the implied volatility is high and receive above average premium. The stock is also anticipated to consolidate (become less volatile) and trading sideway for the duration of your trade.
This is a net credit trade as you are receiving the premium for both the puts and calls options sold.
Remembering that the last month of an option’s life has the greatest amount of time value erosion occurring.
Therefore it is preferably to use this option trading strategy with around 1 month left to expiration so as to give yourself less time to be wrong.
This stock option strategy is typically a bet on the volatility contraction. It is used to try to double the amount of premium collected compare to only trading one side of the market. However, I would like to highlight again that you are exposed to potentially unlimited risk and you should NEVER trade this strategy right before news or earning announcement! You may be earning modest income on this strategy for a few months but one big loss will wipe off your years of gains. It’s just not worth it.
Whether to use a Short Strangle or Short Strangle is typically a
judgment call between amount of premium collected and probability of
stock trading within the range. You should pick the strike price and
time frame of the Short Strangle according to your risk/reward tolerance
and forecast outlook of the underlying stock. Selecting the option
trading strategies with appropriate risk-reward parameters is important
to your long term success in trading options.
Long Iron Condor