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Short Strangle Option Strategy

Short Strangle Option Strategy

What is Short Strangle Option Strategy?

  • Short Strangle is a range bound Strategy that aims to make money wherein you don't expect any movement in stock or there is an expectation of fall in volatility. Short Strangle option strategy demands underlying not to move significantly i.e., this is non directional strategy. In other words, if the underlying fails to show a significant move trader will pocket the premium as the option expires worthless.

When to Execute Short Strangle Option Strategy?

  • Short Strangle is a non-directional strategy, but trade must also be bearish on volatility. It is advised that short Strangle should be implemented when there is no event in near term, and volatility is on the higher side and expected to decrease or can be implemented on low Volatile underlying, where volatility remains sticky for some time. Expiry should be nearest to gain from time decay that happens highest in near term expiry, as DTE (Days to Expiry) decrease.

What is the Trade?

  • Under Short Strangle we Sell 1 lot of Out-of-Money (OTM) Call Option and also, Sell 1 lot of Put Option for the same expiration, distance should be equal between the strike price from the ATM.

Break-Even Point

  • Short Strangle will have 2 break-even points. The breakeven points can be calculated as given below. Lower Breakeven = PE - Net Premium Received. Upper Breakeven = CE + Net Premium Received.

What will be maximum profit?

  • Maximum Profit is defined if market doesn't show significant move above or below the strike sold.

What will be maximum loss?

  • It is a Net credit strategy as we have sold both Call & Put. Maximum Loss is undefined If market shows the significant move and stays in above upper and lower breakeven.

What are the advantages?

  • Being a range-bound strategy, when implemented, gives or creates wealth for a listless movement in the underlying. It provides a broader range of profitability, while time decay is beneficial, as both the options are in short position.

What are the disadvantages?

  • Uncapped/ unlimited Risk on either side, when a large directional move happens, either ways. Hedging cost would be high if stock gives any directional movement.

Example for Short Strangle:

  • Nifty fair future price 2 Feb 2023: 17926.
    Short Strangle can be devised by
    selling one lot of 15200 PE at 144
    selling one lot of 15800 CE at 122
    Net Premium Received = Rs 266, i.e. 266 * 50 = Rs 13,300/-
    Undefined loss potential if stock moves above or below the upper or lower expiry breakeven i.e., 17634 and 18266.
    Max Profit if underlying closes between 17900 - 18000 : Rs 13,300/-

Impact of volatility

  • As volatility rises, option prices - and strangle prices - tend to rise, other factors kept constant, like stock price and time to expiration remain constant. Therefore, when volatility increases, short strangles premiums increase in price and lose money. When volatility falls, short strangles decrease in price and make money. The short strangle option strategy is negative vega and estimates, how much an option price is sensitive to the level of volatility changes and other factors assumed to be unchanged, and negative vega means that a position loses when volatility rises and profits when volatility falls.

Impact of time decay or theta decay

  • The time value component of an option's total price, i.e. option premium decreases as expiration approaches, or DTE (days to expiry) decreases. This is also known as time decay. Since short strangles consist of two short options, the sensitivity to time erosion is higher than for single-option positions. Short strangles option tranding tend to make money as time passes and the underlying stock price does not change, or is listless.