Short Strangle by www.OptionTradingpedia.com

How Does Short Strangle Work in Options Trading?

Short Strangle Risk Graph
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Purpose Of Short Strangle

1. To Profit From Stagnant Stocks
2. To Play "Banker" In A Long Strangle Transaction
3. To Put Time Decay In Your Favor

Expectation Of Short Strangle

Stagnant

Type Of Spread

Naked Option Selling

How To Use Short Strangle?

Sell To Open the same amount of Out Of The Money (OTM) Call Option And Put Option.

Sell OTM Call + Sell OTM Put

Profit Potential of Short Strangle :

This strategy reaches full profit potential when both short call and put options expires out of the money.

Profit Calculation of Short Strangle:

% Return = Net Credit ÷ [(Call Strike Price + Put Premium) - Net Credit]

Risk / Reward of Short Strangle:

Maximum Profit: Limited
Net Credit Made On Establishment Of Positions

Maximum Loss: UnLimited

Break Even Point of Short Strangle:

There are 2 break even points to a Short Strangle. One breakeven point if the underlying asset goes up (Upper Breakeven), and one breakeven point if the underlying asset goes down (Lower Breakeven).

Upper Break Even = Call Strike Price + Net Credit
Lower Break Even = Put Strike Price - Net Credit

Advantages Of Short Strangle :

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.

If the stock remains below the put strike price but above the lower break even the investor will still realize a profit.

If the stock remains above the call strike price but below the upper break even the investor will still realize a profit.

Since two different OTM strike prices are used, the stock can move in a wider range than in the Short Straddle position and still be profitable.

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 Strangle:

Lower net credit than the Short Straddle strategy.

You can lose more money if the underlying asset swings greatly in one direction beyond either the upper or lower breakeven point.

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 option 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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Short Strangle