Inverted Strangle: A Guide for Option Traders
The inverted strangle is a common adjustment option sellers make when their short strikes get tested on a traditional short strangle. This article will cover everything you need to know about the inverted strangle strategy.
Understanding the Short Strangle Strategy
If you are an options seller, you may have heard of the short strangle strategy. It is a popular way to generate income by selling two out-of-the-money options, one call and one put, on the same underlying stock with the same expiration date. The idea is to collect premium and profit from the decay of time value and the stability of the stock price.
While short strangles are high probability trades, there are times when your short strikes get breached, and you must adjust them to manage your risk. That’s where the inverted strangle comes in.
What is an Inverted Strangle?
An inverted strangle is a variation of the short strangle strategy, where you sell two in-the-money options, one call, and one put, on the same underlying stock with the same expiration date. The call strike is higher than the put strike, which creates an inverted position.
Inverted Strangle Risk Diagram
The Inverted Strangle Strategy
Generally, traders do not open inverted strangles as a standalone strategy. Instead, option sellers will adjust their short strangle into an inverted strangle if the stock price breaches one of their strikes.
Inverting Strangle Adjustment From a Traditional Strangle
For example, let’s say you sold the 40 put and 60 strike call on stock ABC when it was trading at $50 per share. Then, it had an earnings announcement and dropped to $30 per share over the next several weeks, testing the short put of the strangle.
You could invert this strangle by rolling the 60 strike call to the 35 strike, which is, of course, lower than your short put, making it an inverted strangle. The benefit of this is you collect more credit and add more bearish exposure to the position, reducing your overall directional risk.
However, if the stock price decides to reverse and move back up, you will likely regret inverting your strangle, so you must be comfortable with taking the additional upside risk. You can also decide to invert your straddle, turning it into an inverted strangle.
Rolling an Inverted Strangle at Expiration
If you hold an inverted strangle until expiration, you will always have at least one option ITM. Therefore, it is highly recommended you roll the inverted strangle to a further date to avoid assignment fees and increased margin requirements.
Additionally, there is much less gamma risk when you roll to a further expiration, and you can collect more premium.
Inverted Strangle Pros and Cons
Before inverting your short strangle, consider these pros and cons:
Pros
Neutralize your delta and directional risk
Collect more credit
Keep your trade alive
Cons
Increased chance of being whipsawed (price reverses after inverting)
ITM options are not ideal to sell
Using a stop loss may be a better option than inverting
The Inverted Strangle | Bottom Line
Inverting a short strangle that goes against you is a great tactic given you understand the pros and cons. If you want to learn more about trading and options strategies, you can join the HaiKhuu Trading community!
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