Short Strangle Options Strategy



Intermediate traders may wish to employ the short strangle strategy. This is a fairly complex strategy which involves selling slightly out of the money put and slightly out of the money call both based on the same asset and expiration date.

This strategy has a limited profit, but potentially unlimited risks. You should only use this strategy if you believe that the underlying asset won’t experience any volatility in its share price for the short term.

Sell 1 Out of The Money (OTM) Call
Sell 1 Out of The Money (OTM) Put

Short Strangle

Maximum Profit

Traders can ear the maximum amount of profit if the stock price of the underlying asset at the date of expiry is between the strike prices of both options sold. When at this price both of the options will expire worthless and you will earn the initial credit as your profit.

It is possible to calculate the maximum profit using the following formula:

Maximum Profit = Net Premium Received – Commissions Paid

Maximum Loss

The short strangle is a fairly risky strategy. It can cause the trader to experience large losses. This happens if the price of the asset is volatile and moves.

You will be able to calculate the losses using the following formula:

Maximum Loss = (Price of Underlying – Strike Price of Short Call – Net Premium Received) OR (Strike Price of Short Put – Price of Underlying – Net Premium Received + Commissions Paid)

Breakeven Point

When using this trading strategy, there are two different breakeven points. These can both be calculated fairly easily using the following:

Upper Breakeven Point = Strike Price of Short Call + Net Premium Received

Lower Breakeven Point = Strike Price of Short Put – Net Premium Received

Short Strangle Example

In April if Google Stock is currently trading at $40, you may then decide to execute a short strangle. To do this you should sell a May 35 put for $100 and a call May 45 for $100. The net credit to enter the trade is $200 and this will also be the maximum profit.

When the options expire, if google stock is still at $40, then both options will expire. This means that you will be able to keep the initial credit as your profit.

If Google Stocks increase in value by the expiry date then the May 35 put will be worthless, but the May 45 call will expire in the money. This will have an intrinsic value of $500 and this means that you will lose $300 (after subtracting initial credits of $200).

Commission

To make it easier for you to understand we have omitted commission payments in all of the examples above. However, if you really decide to do these trades then you will need to pay commission. All brokers charge different rates of commission, although these are normally between $10 and $20.

The more experience you get, the more trading you will do. When you start trading more often, you might want to look for brokers which offer discounted rates for frequent trading. OptionsHouse is one of the best for this because they have a very low rate of $0.15 per contract.

Conclusion

Short Strangle trading strategies are quite easy once you have some experience. These are the opposite to the long strangle, this means if you can do one then you shouldn’t have a problem doing the other.

Once you have some experience with the more basic areas of options trading then you should be able to master Short Strangle strategies. Remember though that the downside is that the risks are unlimited. As long as you trade carefully, you should do ok though.

Practice using this strategy in a virtual environment first. This will make it easier for you to practice and get to grips with the strategy.




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