Short Strangle (Sell Strangle) Explained

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Short Strangle

The Strategy

A short strangle gives you the obligation to buy the stock at strike price A and the obligation to sell the stock at strike price B if the options are assigned. You are predicting the stock price will remain somewhere between strike A and strike B, and the options you sell will expire worthless.

By selling two options, you significantly increase the income you would have achieved from selling a put or a call alone. But that comes at a cost. You have unlimited risk on the upside and substantial downside risk. To avoid being exposed to such risk, you may wish to consider using an iron condor instead.

Like the short straddle, advanced traders might run this strategy to take advantage of a possible decrease in implied volatility. If implied volatility is abnormally high for no apparent reason, the call and put may be overvalued. After the sale, the idea is to wait for volatility to drop and close the position at a profit.

Options Guy’s Tip

You may wish to consider ensuring that strike A and strike B are one standard deviation or more away from the stock price at initiation. That will increase your probability of success. However, the further out-of-the-money the strike prices are, the lower the net credit received will be from this strategy.

The Setup

  • Sell a put, strike price A
  • Sell a call, strike price B
  • Generally, the stock price will be between strikes A and B

NOTE: Both options have the same expiration month.

Who Should Run It

NOTE: This strategy is only for the most advanced traders who like to live dangerously (and watch their accounts constantly).

When to Run It

You are anticipating minimal movement on the stock.

Break-even at Expiration

There are two break-even points:

  • Strike A minus the net credit received.
  • Strike B plus the net credit received.

The Sweet Spot

You want the stock at or between strikes A and B at expiration, so the options expire worthless.

Maximum Potential Profit

Potential profit is limited to the net credit received.

Maximum Potential Loss

If the stock goes up, your losses could be theoretically unlimited.

If the stock goes down, your losses may be substantial but limited to strike A minus the net credit received.

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Ally Invest Margin Requirement

Margin requirement is the short call or short put requirement (whichever is greater), plus the premium received from the other side.

NOTE: The net credit received from establishing the short strangle may be applied to the initial margin requirement.

After this position is established, an ongoing maintenance margin requirement may apply. That means depending on how the underlying performs, an increase (or decrease) in the required margin is possible. Keep in mind this requirement is subject to change and is on a per-unit basis. So don’t forget to multiply by the total number of units when you’re doing the math.

As Time Goes By

For this strategy, time decay is your best friend. It works doubly in your favor, eroding the price of both options you sold. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.

Implied Volatility

After the strategy is established, you really want implied volatility to decrease. An increase in implied volatility is dangerous because it works doubly against you by increasing the price of both options you sold. That means if you wish to close your position prior to expiration, it will be more expensive to buy back those options.

An increase in implied volatility also suggests an increased possibility of a price swing, whereas you want the stock price to remain stable between strike A and strike B.

Check your strategy with Ally Invest tools

  • Use the Profit + Loss Calculator to establish break-even points, evaluate how your strategy might change as expiration approaches, and analyze the Option Greeks.
  • Use the Probability Calculator to verify that both the call and put you sell are about one standard deviation out-of-the-money.
  • Examine the stock’s Volatility Charts. If you’re doing this as a volatility strategy, you want to see implied volatility abnormally high compared with historic volatility.

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Long Strangle (Buy Strangle) Options Trading Strategy Explained

Published on Thursday, April 19, 2020 | Modified on Wednesday, June 5, 2020

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Long Strangle (Buy Strangle) Options Strategy

Strategy Level Beginners
Instruments Traded Call + Put
Number of Positions 2
Market View Neutral
Risk Profile Limited
Reward Profile Unlimited
Breakeven Point two break-even points

The Long Strangle (or Buy Strangle or Option Strangle) is a neutral strategy wherein Slightly OTM Put Options and Slightly OTM Call are bought simultaneously with same underlying asset and expiry date.

This strategy can be used when the trader expects that the underlying stock will experience significant volatility in the near term.

It is a limited risk and unlimited reward strategy. The maximum loss is the net premium paid while maximum profit is achieved when the underlying moves either significantly upwards or downwards at expiration.

The usual Long Strangle Strategy looks like as below for NIFTY current index value at 10400 (NIFTY Spot Price):

Options Strangle Orders

Orders NIFTY Strike Price
Buy 1 Slightly OTM Put NIFTY18APR10200PE
Buy 1 Slightly OTM Call NIFTY18APR10600CE

Suppose Nifty is currently at 10400 and due to some upcoming events you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty Put at 10200 and buying Nifty Call at 10600. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves.

When to use Long Strangle (Buy Strangle) strategy?

A Long Strangle is meant for special scenarios where you foresee a lot of volatility in the market due to election results, budget, policy change, annual result announcements etc.

Example

Example 1 – Stock Options:

Let’s take a simple example of a stock trading at в‚№40 (spot price) in June. The option contracts for this stock are available at the premium of:

  • July 35 Put – в‚№1
  • July 45 Call – в‚№1

Lot size: 100 shares in 1 lot

  1. Buy ‘July 35 Put’: 100*1 = 100
  2. Buy ‘July 45 Call’: 100*1 = 100

Net Debit: в‚№100 + в‚№100 = в‚№200

Now let’s discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at в‚№40

In this situation,

  • July 35 Put – Expires worthless
  • July 45 Call – Expires worthless
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Loss = в‚№200

The total loss of в‚№200 is also the maximum loss in this strategy.

Scenario 2: Stock price goes above в‚№50

In this situation,

  • July 35 Put – Expires worthless
  • July 45 Call Expires in-the-money with an intrinsic value of (50-45)*100 = в‚№500
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Profit = в‚№500 – в‚№200 = в‚№300

Scenario 3: Stock price goes down to в‚№30

In this situation,

  • July 35 Put Expires in-the-money with an intrinsic value of (35-30)*100 = в‚№500
  • July 45 Call – Expires worthless
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Profit = в‚№500 – в‚№200 = в‚№300

Example 2 – Bank Nifty

Long Strangle Example Bank Nifty
Bank Nifty Spot Price 8900
Bank Nifty Lot Size 25
Long Strangle Options Strategy
Strike Price(в‚№) Premium(в‚№) Total Premium Paid(в‚№)
(Premium * lot size 25)
Buy 1 OTM Call 9000 200 5000
Buy 1 OTM Put 8800 100 2500
Net Premium (200+100) 300 7500
Upper Breakeven(в‚№) Strike price of Call + Net Premium
(9000 + 300)
9300
Lower Breakeven(в‚№) Strike price of put – Net Premium
(8800 – 300)
8500
Maximum Possible Loss (в‚№) Net Premium Paid 7500
Maximum Possible Profit (в‚№) Unlimited
On Expiry Bank NIFTY closes at Net Payoff from 1 OTM Call bought (в‚№) @9000 Net Payoff from 1 OTM Put Bought (в‚№) @8800 Net Payoff (в‚№)
8000 -5000 17500 12500
8300 -5000 10000 5000
8500 -5000 5000 0
9000 -5000 -2500 -7500
9300 2500 -2500 0
9500 7500 -2500 5000
9800 15000 -2500 12500

Market View – Neutral

When you are unsure of the direction of the underlying but expecting high volatility in it.

Actions

  • Buy OTM Call Option
  • Buy OTM Put Option

Suppose Nifty is currently at 10400 and you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty at 10600 and at 10800. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves.

Breakeven Point

two break-even points

A Options Strangle strategy has two break-even points.

Lower Breakeven Point = Strike Price of Put – Net Premium

Upper Breakeven Point = Strike Price of Call + Net Premium

Risk Profile of Long Strangle (Buy Strangle)

Limited

Max Loss = Net Premium Paid

The maximum loss is limited to the net premium paid in the long strangle strategy. It occurs when the price of the underlying is trading between the strike price of Options.

Reward Profile of Long Strangle (Buy Strangle)

Unlimited

Maximum profit is achieved when the underlying moves significantly up and down at expiration.

Profit = Price of Underlying – Strike Price of Long Call – Net Premium Paid

Profit = Strike Price of Long Put – Price of Underlying – Net Premium Paid

Strangle

What Is a Strangle?

A strangle is an options strategy where the investor holds a position in both a call and a put option with different strike prices, but with the same expiration date and underlying asset. A strangle is a good strategy if you think the underlying security will experience a large price movement in the near future but are unsure of the direction. However, it is profitable mainly if the asset does swing sharply in price.

A strangle is similar to a straddle, but uses options at different strike prices, while a straddle uses a call and put at the same strike price.

Key Takeaways

  • A strangle is a popular options strategy that involves holding both a call and a put on the same underlying asset.
  • A strangle covers investors who think an asset will move dramatically but are unsure of the direction.
  • A strangle is profitable only if the underlying asset does swing sharply in price.

Strangle

How Does a Strangle Work?

Strangles come in two forms:

  1. In a long strangle—the more common strategy—the investor simultaneously buys an out-of-the-money call and an out-of-the-money put option. The call option’s strike price is higher than the underlying asset’s current market price, while the put has a strike price that is lower than the asset’s market price. This strategy has large profit potential since the call option has theoretically unlimited upside if the underlying asset rises in price, while the put option can profit if the underlying asset falls. The risk on the trade is limited to the premium paid for the two options.
  2. An investor doing a short strangle simultaneously sells an out-of-the-money put and an out-of-the-money call. This approach is a neutral strategy with limited profit potential. A short strangle profits when the price of the underlying stock trades in a narrow range between the breakeven points. The maximum profit is equivalent to the net premium received for writing the two options, less trading costs.

A Strangle vs. a Straddle

Strangles and straddles are similar options strategies that allow investors to profit from large moves to the upside or downside. However, a long straddle involves simultaneously buying at the money call and put options—where the strike price is identical to the underlying asset’s market price—rather than out-of-the-money options. A short straddle is similar to a short strangle, with limited profit potential that is equivalent to the premium collected from writing the at the money call and put options.

With the straddle, the investor profits when the price of the security rises or falls from the strike price just by an amount more than the total cost of the premium. So it doesn’t require as large a price jump. Buying a strangle is generally less expensive than a straddle—but it carries greater risk because the underlying asset needs to make a bigger move to generate a profit.

Benefits from asset’s price move in either direction

Cheaper than other options strategies, like straddles

Unlimited profit potential

Requires big change in asset’s price

May carry more risk than other strategies

Real World Example of a Strangle

To illustrate, let’s say that Starbucks (SBUX) is currently trading at US$50 per share. To employ the strangle option strategy, a trader enters into two option positions, one call and one put. The call has a strike of $52, and the premium is $3, for a total cost of $300 ($3 x 100 shares). The put option has a strike price of $48, and the premium is $2.85, for a total cost of $285 ($2.85 x 100 shares). Both options have the same expiration date.

If the price of the stock stays between $48 and $52 over the life of the option, the loss to the trader will be $585, which is the total cost of the two option contracts ($300 + $285).

However, let’s say Starbucks’ stock experiences some volatility. If the price of the shares ends up at $40, the call option will expire worthlessly, and the loss will be $300 for that option. However, the put option has gained value and produces a profit of $715 ($1,000 less the initial option cost of $285) for that option. Therefore, the total gain to the trader is $415 ($715 profit – $300 loss).

If the price rises to $55, the put option expires worthless and incurs a loss of $285. The call option brings in a profit of $200 ($500 value – $300 cost). When the loss from the put option is factored in, the trade incurs a loss of $85 ($200 profit – $285) because the price move wasn’t large enough to compensate for the cost of the options. The operative concept is the move being big enough. If Starbucks had risen $10 in price, to $60 per share, the total gain would have again been $415 ($1000 value – $300 for call option premium – $285 for an expired put option).

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