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Short Gut - Introduction
The Short Gut is a neutral options strategy that allows an options trader to profit when the underlying stock stays
stagnant or within a pre-determined trading range. The Short Gut has the widest profitable range of all neutral options strategies
but with also the lowest maximum profit potential. Yes, safety and profit is inversely proportional in options trading. The Short Gut
profits primarily from time decay of the extrinsic value of options, putting the greatest enemy
in options trading into its advantage. It involves the sale of a Long Gut position so learning the Long Gut first makes the
Short Gut easier to understand.
Please Read About The Long Gut.
Because you recieve money for writing a Short Gut, it is classified as a Credit Spread. Most other neutral options strategies require you to pay
money to put on the trade. Those are known as Debit Spreads. Examples of such Debit Spread neutral strategies that profit when a stock is stagnant would be Butterfly Spreads and Covered Calls.
For implications pertaining to Credit Spreads and Debit Spreads, please go to our Debit & Credit Spreads Page.
When To Use Short Gut?
Use a Short Gut when you expect the underlying
asset to trade within a pre-determined trading range or stay stagnant until expiration .
Why Not A Short Straddle or Short Strangle?
The Short Gut has a much wider profitable range than the
short straddle or
short strangle and therefore allows for more uncertainty.
Being a safer neutral strategy than the other two, it compensates by having also the lowest profitability. This is the kind of
trade-off in
options trading that all options traders should be familar with.
How To Use Short Gut?
Establishing a Short Gut simply involves simultaneously
selling to open (or writing)
in the money (ITM) call options and
an equal number of in the money (ITM)
Put options on the underlying asset.
Both short In The Money options offset each other when the underlying stock moves so that movement in the underlying stock do not affect the
value of the position negatively while the extrinsic value of both options decay as time goes by, producing its profit.
How deep in the money should the options be depends on how wide you wish the profitable range to be. The deeper in the money the
strike price of the call and put options are, the wider the profitable range but the lower the maximum profit as
extrinsic values decline
as options move deeper in the money. The difference between the strike price of both options and the prevailing price of the underlying stock
should ideally be the same. This is so that the
delta value of the call and put options offset each other as much
as possible, resulting in a
delta neutral position.
Short Gut Spread Example
Assuming QQQQ at $44. Sell To Open
QQQQ Jan39Call, sell To Open QQQQ Jan49Put
Notice that the difference between the strike price of both options and the price of the stock is the same at $5.
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Trading Level Required For Short Gut Spread
A Level 5 options trading account that allows the execution of writing naked options is needed for the Short Gut Spread. Read more about Options Account Trading Levels.
Profit Potential of Short Gut :
The Short Gut realizes its maximum profit potential as long as the underlying stock remains within the range bounded by the strike prices of
the short call and put options.
Profit Calculation of Short Gut:
Maximum profit is limited to the sum of their extrinsic values.
Short Gut Spread Calculation
Assuming QQQQ at $44. Sell To Open
QQQQ Jan39Call, sell To Open QQQQ Jan49Put
If the Jan39Call is trading at $5.50 and the Jan49Put trading at $5.45, the maximum profit of the position is $0.50 + $0.45 = $0.95.
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Risk / Reward of Short Gut:
Maximum Profit: Limited
Maximum Loss: UnLimited
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Profitable Range of Short Gut:
The profitable range of a Short Gut is the range bounded by the upper and lower breakeven points within which the position
will return a profit. Conversely, it is also the range beyond which the position would start making a loss.
Upper Break Even = Put Strike + Maximum Profit
Lower Break Even = Call Strike - Maximum Profit
Following up on the above example:
Upper Break Even = Put Strike + Maximum Profit = $49.00 + $0.95 = $49.95
Lower Break Even = Call Strike - Maximum Profit = $39.00 - $0.95 = $38.05
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Advantages Of Short Gut :
:: Able to profit when underlying asset stays stagnant or within a tight trading range.
:: As this is a credit spread position, you are already paid your full profit the moment the position is put on. That reduces risk.
:: Higher chance of ending up in full profit than a short straddle or short strangle.
:: If volatility is high when the position is put on, a drop in volatility after the position is put on can result in a profit.
Disadvantages Of Short Gut:
:: Lower profitability than the short strangle or short straddle.
:: Potential loss is unlimited and can collect to very big amounts if the underlying stock continues strongly in one direction.
:: Because of this risk, the margin requirements for this
strategy are fairly high. Your
options broker may require you to cover both options
as if they were two Naked Options, or they may require a cash value
of the Option Strike Price plus the highest bid of the call or the put.
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