Strategy

short strangle

Type of Strategy

trading

sentiment

neutral

implied volatility

high

example

XYZ at $40.  Sell a 45-dte $45 strike call and $35 Put for $1 each.

boundaries

max loss = undefined

max profit = $2 ($1 + $1)

Breakeven = $33, $47     (strikes +/- credit recvd)

description

Concurrently sell an OTM call and an OTM put with the same expiration.

Set-Up

Sell/short 1 call at strike price ATM+X with expiration Z.

Sell/short 1 put at strike price ATM-Y with expiration Z.

Note: Strike price selection may be centered on the ATM price, although any OTM strike prices may be chosen.

Soi perspective

SOI does not recommend pure short strangles due to unlimited risk to the upside.  Purchasing a small delta call for protection can provide a means to define the upside risk with minimal impact on the strategy profile.

Traders should avoid long strangles, as long premium strategies historically provide negative returns.

Traders commonly use short strangles in their portfolios.  Since implied volatility often eclipses realized volatility, short premium strategies such as short strangles are generally profitable within a probabilistic distribution.

Additionally, short straddles and short strangles offer traders the ability to manage the trade based on underlying price movement.  With significant risk in short strangles, risk management is key, both at order entry and reactionary to market moves.

 

guidelines

I. Short strangles are often established with the strike prices near the one standard deviation expectation, equivalent to about 16 delta.

II. SOI recommends purchasing a very low delta call to define upside risk when implementing a short strangle.

 

management

Traders generally enter short strangles with approximately 45 DTE.

Profit targets of 50% of the credit received should be taken if available prior to reaching 21 DTE.

If the underlying stock price starts to challenge one side of the strangle, the trader should first consider rolling down the untested side to provide additional credit (and reduce risk).

Experienced traders may even roll down the untested side below the challenged leg, thus achieving an inversion.  SOI recommends a strong understanding of strategies and return profiles before inverting a short strangle.  Inversion requires an accurate record of past transactions and adjustments to a position to understand inversion return profiles.

If 50% profit has not been achieved at 21 DTE, the trader should consider either closing the transaction or rolling the transaction out in time, if the rollout can be done for a credit.  Based on the scenario, either one leg or both legs of the strangle can be rolled out.

image from www.theoptionsguide.com

example – XYZ in detail

I. XYZ at $40.  Sell a 45 DTE $35 put for $1 & a 45 DTE $45 call for $1.05.  Buy a 45 DTE $70 call for $0.05.

II. Stock at $40.  Strikes at $35, $45.  Net Premium Received = $2.  Break-Evens at $33, $47

Short Strangle: XYZ

image from www.theoptionsguide.com

activity & management – xyz

Upon trade entry, a good-until-cancelled (GTC) buy-to-close (BTC) order is placed to purchase the strangle, thus exiting the trade, for a max $1 debit (50% premium).  Eight days in, XYZ has fallen to $34.50.  Since the underlying has now challenged and broken the short put, the trader decides to assess management options.

As a first step, the trader buys back the short $45 call for $0.20 and sells a $40 call for $0.55, a $0.35 net credit.  In executing this trade, the total premium collected has now increased to $2.35.  The new Break-Even points are $32.65 and $42.35.

The trader institutes a new GTC BTC order for a $1.2 debit (50% of net premium received).

The stock hovers within $33 – $35 over the next two weeks.  Reaching 21 DTE, the XYZ is $33.50.  There are now two recommended scenarios, as the trader does not want to invert. 

1) The strangle can be bought for $2.75, a $0.40 loss.

2) The strangle can be rolled.  In both cases, a new $70 call is purchased for protection.

  A. Rolling out with the same strikes ($35/$40) provides a $1.4 credit. 

  B. Rolling out to a $33 put and a $45 call can be done for even money.

The roll down and out is chosen, resulting in a 56 DTE position short a $33 put and a $45 call, with a long $70 call.  A new GTC BTC order is placed to exit the trade for a debit of $1.2 (50% net credit) and the cycle resumes.