Short Strangle Option Strategy: A Guide for Traders
If you are looking for a way to profit from a neutral or range-bound market, you might want to consider the short strangle option strategy. A short strangle involves selling an out-of-the-money call and an out-of-the-money put with the same expiration date on the same underlying asset.
The idea is to collect the premium from both options and hope that the price of the underlying asset stays within a narrow range until expiration, so that both options expire worthless and you keep the entire premium as profit.
What is a Short Strangle?
A short strangle is an advanced option strategy that involves selling two options with different strike prices but the same expiration date on the same underlying asset. The strike price of the call option is higher than the current price of the underlying asset, while the strike price of the put option is lower than the current price of the underlying asset. This creates a “strangle” around the price of the underlying asset, as shown in the diagram below:
The short strangle strategy is also known as a naked strangle or an uncovered strangle, because you are selling options without owning the underlying asset or another option to hedge your risk. This means that you have unlimited risk if the price of the underlying asset moves significantly beyond either strike price.
Short Strangle Strategy
The short strangle strategy is suitable for traders who have a neutral or slightly bullish or bearish outlook on the market and expect low volatility in the near term. The goal is to collect the premium from selling both options and hope that they expire worthless or can be bought back at a lower price before expiration.
To execute a short strangle, you need to:
Choose an underlying asset that you believe will trade within a narrow range until expiration
Choose an expiration date that is relatively close, usually within 30 to 60 days
Choose a strike price for the call option that is above the current price of the underlying asset, preferably at least one standard deviation away
Choose a strike price for the put option that is below the current price of the underlying asset, preferably at least one standard deviation away
Sell both options simultaneously and collect the premium
The premium you receive from selling both options is your maximum potential profit. You will realize this profit if both options expire worthless or can be bought back at a lower price before expiration.
Your breakeven points are calculated by adding and subtracting the premium from the strike prices of the options. For example, if you sell a 50 call and a 40 put for $1 total, your breakeven points are 51 and 39.
Your maximum potential loss is unlimited if the price of the underlying asset moves significantly beyond either strike price. You will incur a loss if either option is exercised or can only be bought back at a higher price before expiration.
Short Strangle Risk Diagram
Short Strangle Risk Management
The short strangle strategy is considered very risky because it exposes you to unlimited loss potential if the price of the underlying asset moves significantly beyond either strike price. Therefore, it is important to manage your risk carefully and monitor your position closely.
Some of the ways to manage your risk are:
Use stop-loss orders to limit your losses if either option goes in-the-money
Close your position or roll it to another expiration date if there is a significant change in your market outlook or volatility expectations
Hedge your position with another option or futures contract to reduce your exposure to directional risk
Understand margin and do not overleverage your account
Short Strangle Adjustments
The short strangle strategy can be adjusted in various ways to improve your chances of success or reduce your risk exposure. Some of the common adjustments are:
Rolling up or down: This involves buying back one of the options and selling another one with a higher or lower strike price, respectively. This can be done to capture more premium, reduce your delta exposure, or move your breakeven points further away from the current price of the underlying asset.
Rolling out: This involves buying back both options and selling another pair with a later expiration date. This can be done to extend your time horizon, collect more premium, or reduce your gamma exposure.
Converting to an iron condor: This involves buying an out-of-the-money call and an out-of-the-money put with the same expiration date as your short strangle, creating a four-legged spread. This can be done to limit your loss potential, reduce your margin requirement, or increase your probability of profit.
Short Strangle vs. Iron Condor
The short strangle and the iron condor are both neutral option strategies that involve selling two options with different strike prices but the same expiration date on the same underlying asset. The main difference is that the iron condor also involves buying two options with further out-of-the-money strike prices, creating a defined risk and reward profile.
Short Strangle Advantages and Disadvantages
Advantages: Higher premium received, lower commissions, higher probability of profit, easier to adjust
Disadvantages: Unlimited loss potential, higher margin requirement, higher risk of early assignment, higher exposure to volatility and directional risk
Iron Condor Advantages and Disadvantages
Advantages: Limited loss potential, lower margin requirement, lower exposure to volatility and directional risk
Disadvantages: Lower premium received, higher commissions, lower probability of profit, harder to adjust
Long Strangle vs. Short Strangle
The long strangle and the short strangle are opposite option strategies that involve buying or selling two options with different strike prices but the same expiration date on the same underlying asset. The only difference is that the long strangle involves buying an out-of-the-money call and an out-of-the-money put, while the short strangle involves selling them.
Long Strangle Advantages and Disadvantages
Advantages: Unlimited profit potential, limited loss potential, lower margin requirement, higher exposure to volatility and directional risk
Disadvantages: Higher premium paid, lower probability of profit, higher risk of time decay, harder to adjust
Short Strangle Advantages and Disadvantages
Advantages: Lower premium paid, higher probability of profit, lower risk of time decay, easier to adjust
Disadvantages: Limited profit potential, unlimited loss potential, higher margin requirement, lower exposure to volatility and directional risk
The Short Strangle | Bottom Line
The short strangle option strategy is a way to profit from a neutral or range-bound market by selling an out-of-the-money call and an out-of-the-money put with the same expiration date on the same underlying asset. The goal is to collect the premium from both options and hope that they expire worthless or can be bought back at a lower price before expiration.
The short strangle strategy is suitable for traders who have a neutral or slightly bullish or bearish outlook on the market and expect low volatility in the near term. However, if the stock price moves significantly in either direction, the short strangle will generate a loss.
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FAQ
Q: What is the risk of the short strangle strategy?
A: The risk of short strangle strategy is unlimited if the price of the underlying asset moves significantly beyond either strike price. You will incur a loss if either option is exercised or can only be bought back at a higher price before expiration. Therefore, it is important to manage your risk carefully and monitor your position closely.
Q: How profitable is the short strangle?
A: The profitability of short strangle depends on several factors, such as the premium received, the volatility of the underlying asset, the time decay of the options, and the price movement of the underlying asset. The maximum potential profit is the premium received from selling both options. You will realize this profit if both options expire worthless or can be bought back at a lower price before expiration.
Q: What are the disadvantages of the short strangle?
A: The disadvantages of short strangle are:
Unlimited loss potential
Higher margin requirement
Higher risk of early assignment
Higher exposure to volatility and directional risk
Q: What are the advantages of the short strangle?
A: The advantages of short strangle are:
Higher premium received
Lower commissions
Higher probability of profit
Easier to adjust
Q: Is the short strangle always profitable?
A: No, the short strangle is not always profitable. The short strangle is a a relatively consisntent strategy, but you can lose trades with volatility rapidly increases or the stock price moves rapidly in one direction.
Q: What is the best delta for strangles?
A: The best delta for strangles depends on your risk tolerance and market outlook. Generally, a lower delta means a lower risk, but also a lower premium received or paid. A higher delta means higher risk, but also a higher premium received or paid.
Q: What is the success rate of the short strangle option strategy?
A: The success rate of the short strangle option strategy depends on your overall strategy and which deltas you sell. The success rate can be estimated by using the probability calculator or by looking at the delta of the options.
For example, if you sell a short strangle with a delta of 0.16 for both options, you have a 68% probability of both options expiring worthless (assuming a normal distribution), which means you have a 68% success rate. However, this does not mean that you will make money 68% of the time, because you still have to account for your potential losses if either option goes in-the-money.
Q: What is an example of a short strangle option?
A: An example of a short strangle option is:
Underlying asset: XYZ stock
Current price: $50
Expiration date: July 16, 2023
Call option strike price: $55
Put option strike price: $45
Premium received: $1
In this example, you sell a 55 call and a 45 put for $1 total and collect $100. Your maximum potential profit is $100 if both options expire worthless or can be bought back at a lower price before expiration. Your breakeven points are $56 and $44. Your maximum potential loss is unlimited if the price of XYZ stock moves significantly beyond either strike price.
