Short Strangle

Short Strangle

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

Basics Concepts – Short Strangle

Description – Short Strangle

Instead of selling ATM options, we sell OTM calls and puts, which means a lower net credit but typically wider breakeven points.
The Short Strangle is precisely the opposite of a (Long) Strangle.
We short OTM puts and calls with a short time to expiration (one month or less) in order to pick up income.
As this Strategy exposed to potentially unlimited risk, which is another reason for making this a short-term strategy.
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 OTM (lower) strike puts, preferably with one month or
less to expiration.
Sell OTM (higher) strike calls with the same expiration.

Context - Short Strangle

Outlook

With Short Strangles, 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 netcredit you receive for selling the calls and puts.

Effect of Time Decay

Time decay is helpful to Short Strangles.
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 least months out.

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

Steps to Trading a Short Strangle

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 Strangle

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.
Advanced traders may consider buying further OTM calls and puts on either side in order to create a Long Iron Butterfly, which is more conservative.

Advantages and Disadvantages

Advantages

Profit from a range bound stock.
Comparatively high-yielding income strategy

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.

Share this Content

Derivatives Analysis

Basic Option Strategy