Short Guts

Short Guts

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Short Guts

Description – Short Guts

The Short Guts is a simple adjustment to the Short Strangle that increases the net credit.
Instead of selling OTM options, we sell ITM calls and puts, which creates a higher net credit.
The Short Guts is precisely the opposite of a (Long) Guts. We short ITM puts and calls with a short time to expiration in order to pick up income.
Each leg of the trade has uncapped downside.
If the stock starts going ballistic in either direction, then your position is precarious to say the least.
If the stock remains range bound, then we’ll make a limited profit.
You would never trade this strategy right before a news event like an earnings report.
You certainly wouldn’t want any nasty surprises to be lurking around the corner.
Sell ITM (lower) strike calls, preferably with one month or less to expiration.
Sell ITM (higher) strike puts with the same expiration.

Context - Short Guts

Outlook

With Short Guts, your outlook is direction neutral—you are looking for no movement in the stock.

Rationale

To execute a direction-neutral income strategy for a net credit while expecting a future decline in volatility.
Ideally you are looking for a scenario where the immediate Implied Volatility has been high, giving you above average options premiums, but where you anticipate the stock to consolidate (become less volatile) and remain range bound for the duration of your trade.

Net Position

This is a net credit trade because you have sold calls and puts.
Your maximum risk on the trade itself is unlimited, whereas your maximum reward is limited to the net
credit you receive for selling the calls and puts.

Effect of Time Decay

Time decay is helpful to Short Guts.
Because you are short in options, and because you are exposed to unlimited downside, you want to be exposed to this position for as little time as possible.
Time Period to Trade
At Nearby Expiry

Breakeven Down = [Lower Strike – Net Credit + Difference in Strikes]
Breakeven Up = [Higher Strike + Net Credit – Difference in Strikes]

Steps to Trading a Short Guts

Steps In

Try to ensure that the trend is range bound and identify clear areas of support and resistance.
Try to ensure that no news is coming out soon for the stock.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
Close the losing side by buying back the relevant option if the stock breaks support or resistance.
Buy back both options if the position is profitable but you think news may emerge about the underlying stock.

Exiting the Trade - Short Guts

Exiting the Position

With this strategy, you can simply unravel the spread by buying back your calls and puts.

Mitigating a Loss

Buy back your sold options.

Advantages and Disadvantages

Advantages

Profit from a range bound stock.
Comparatively high-yielding income strategy.
High premiums because both options are ITM.

Disadvantages

Uncapped risk if the stock moves in either direction.
Capped reward.
Almost certain exercise at expiration.
Bid/Ask Spread can adversely affect the quality of the trade.
High-risk strategy; not for novices or intermediates.

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