A Short Strangle is an adaptation of the Short Straddle, with a view to achieving maximum profitability for the seller of the option through the expansion of breakeven points. It is a strategy where an out-of-the-money (OTM) call and an OTM put on the same underlying with the same expiry date are shorted together.
By selling both options, the trader receives a net credit, which is less than in a Short Straddle. However, the higher breakeven points lower the probability of the trade resulting in a loss. In order to make a profit through a Short Strangle, the underlying stock price needs to remain range-bound between these breakeven points until the date of expiry. If the underlying stock price fails to move too much, the options expire, and the seller retains the premium as profit.
When to Use
Use this strategy when a speculator is anticipating that the underlying stock will have minimal volatility during the option’s duration.
Risk & Reward
- Risk: Unlimited provided the stock experiences a substantial price movement beyond the breakeven points.
- Reward: Limited by the premium accumulated from selling both options.
Breakeven Points
Upper Breakeven = Short Call Strike Price + Net Premium Earned
Lower Breakeven = Short Put Strike Price – Net Premium Earned
Conclusion
Short Strangle is a favourite among option investors who want to make money through low volatility. It has more chances of succeeding compared to Short Straddle but is very dangerous if the underlying stock is volatile. The trader must carefully review market conditions and risk appetite prior to using this strategy. Proper risk management is necessary to avoid astronomical losses.
