Short Strangle Option Strategy – What to Know

Options trading in India has witnessed a significant surge in popularity, with more and more Indian investors showing a keen interest in derivative trading. As the market evolves, it becomes crucial to explore and understand specific strategies that can be employed to maximise potential gains while managing risk. One such strategy is the Short Strangle Option Strategy, which offers traders the opportunity to capitalize on a range-bound market by simultaneously selling an out-of-the-money call option and an out-of-the-money put option.

Topics Covered:

• What is the Short Strangle Option Strategy?
• How Does the Short Strangle Option Strategy Work?
• Tips for Short Strangle Option Strategy
• Conclusion

What is the Short Strangle Option Strategy?

The Short Strangle Option Strategy is a popular options trading strategy investors use to profit from a range-bound market. It involves simultaneously selling an out-of-the-money call option and an out-of-the-money put option.

This strategy is considered neutral as it does not rely on the market moving in a specific direction but rather on the underlying asset's price staying within a certain range. The primary objective of the Short Strangle Option Strategy is to capture the premium received from selling the options, as both the call and put options will eventually expire worthless if the price remains within the specified range.

Let's understand this by a short strangle strategy example.

Consider a trader in the Indian stock market who implements this strategy on a stock like Reliance Industries Limited, traded on the NSE. The trader sells a call option with a strike price above the current stock price and a put option with a strike price below the current stock price. Both options are set to expire in the same month.

This strategy would ideally profit if Reliance's stock price remains relatively stable, staying within the range set by the strike prices of the options sold. However, the trader faces unlimited risk if the stock price moves significantly beyond either of the strike prices, highlighting the need for careful strategy and risk management in the Indian context.

How Does the Short Strangle Option Strategy Work?

The trader sells an out-of-the-money call option with a strike price above the current stock price and an out-of-the-money put option with a strike price below the current stock price. By selling these options, the trader collects premiums as income.

Additionally Read: What is Demat Account?

The goal is for the underlying stock to remain within a certain price range until the options expire. If this occurs, both the call and put options will expire worthless, allowing the trader to keep the premium received.

Profits from Range-Bound Market:

The Short Strangle Strategy generates profits when the underlying stock stays within a specific price range. When the stock price remains between the strike price of the call option and the put option, both options expire worthless, and the trader retains the premiums collected. This results in a net profit equal to the total premium received.

Also Read: What is Call Option

Risks in Volatile Market Conditions:

While the strategy can be profitable in a range-bound market, it is essential to consider the risks, especially in volatile conditions. The stock price may move significantly in a volatile market, breaching the established range.

This can lead to potential losses if the stock price exceeds the call or put option's strike price. Additionally, the trader may face increased margin requirements and potential assignment risk if the stock moves against the position.

Tips for Short Strangle Option Strategy

Follow the below tips:

1. Risk Management: Implementing proper risk management techniques is crucial when executing this strategy. As a trader, set predetermined maximum loss levels and stick to them. Determine the amount of capital you are willing to risk on each trade and set stop-loss orders accordingly.

2. Choosing the Right Strike Prices: Selecting the appropriate strike prices is key to the success of this strategy. The ideal scenario is to choose strike prices outside of the expected trading range for the underlying stock. This increases the probability of both options expiring worthless and allows you to collect the maximum premium.

3. Market Analysis: Conduct a thorough market analysis before implementing the Short Strangle Strategy. Consider historical price patterns, volatility levels, and upcoming events that may impact the stock's movement. Understanding the market conditions and trends will help you make informed decisions when selecting strike prices and managing your positions.

4. Ongoing Education: The financial markets are constantly evolving, and staying updated with the latest trends and strategies is crucial. Continuously educate yourself through books, online resources, and seminars to enhance your knowledge and skills in options trading. This will enable you to adapt to changing market dynamics and improve profitability.

5. Stay Updated with Market Trends: Keep a close eye on market trends, news, and economic indicators that may affect the underlying stock. Stay informed about upcoming earnings reports, economic releases, and industry-specific developments. This information can help you make timely adjustments to your positions and avoid potential risks.

Conclusion

The short strangle option strategy can be viable for more experienced investors looking to generate income in a neutral or slightly volatile market. As with any investment strategy, it is important to thoroughly research and understand the risks involved before implementing it in your portfolio.

The short strangle option strategy involves simultaneously selling an out-of-the-money call and put option, anticipating minimal movement in the underlying asset's price. Optimize your options trading approach by demat account opening, facilitating convenient execution and management of short strangle positions for potential profit.