High profits with Selling Strangles

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For trading strangles you need a little more knowledge about selling options. Most likely you start with selling a naked put with the strike price just under the stock price. There are others who like to sell calls just a little above the stock price. You do this in the hope you can keep the credit which you received.

A strangle is a strategy that consists of selling both a short call option and a short put option which expire in the same month. This is how the trade looks like: we are selling options, we sell 1 OTM Call and 1 OTM Put. In principle the stock can go to zero therefore this type of trade has undefined risk.

The strategy is profitable if the price of the underlying stock stays above the strike price of the short put and below the strike price of the short call. The trade will lose money as the price of the underlying stock moves outside of the established range, that is the break even points. A strangle is a great strategy to consider deploying when a stock has an IV Rank above 50. How do you trade a strangle?

Before selling a strangle, we need to consider the probabilities involved with the trade. We want the price of the underlying to stay between our short strikes, therefore it’s important to know the probability of our short strikes expiring OTM when placing the trade. If both of our short strikes expire OTM then we will realize maximum profit. In this situation we will keep the entire credit received when initially selling the strangle. As a benchmark we tend to set our strangle at the strikes that have a probability of expiring OTM of 84%.

 

Short Strangle Options Strategies

With short strangles being a very common strategy we like to use to sell option premium. Tastytrade decided to conduct a mega study investigating the strategy’s performance in different volatility environments. For the study, we went back approximately 5 years and sold a 1 standard deviation strangle with 45 days-to-expiration in 5 different underlying on the first trading day of every month. This gave us a total of 314 occurrences.

While the strangle has a high probability of profit, it’s also an advanced type of trade that has undefined risk. This trade has greater risk than a vertical spread or an iron condor since the call and put options that are sold are naked options. Though, as a function of the trade’s undefined risk, it tends to deliver a higher return on capital than a defined risk trade.

Read more https://www.tastytrade.com/tt/learn/strangle?locale=en-US#

 

Outlook: With this stock option trading strategy, your outlook is directional neutral.

You are expecting a drop in volatility or no movement of the underlying stock.

Risk and Reward

Maximum Risk:

  • Unlimited to the upward or downward movement of the underlying stock.

Maximum Reward :

  • Limited to the Net Premium Collected from the Out of The Money puts and calls options sold.

Breakeven :

  • Upside Breakeven = Strike Price Plus Net Premium Collected
  • Downside Breakeven = Strike Price Less Net Premium Collected

Net Position:

  • This is a net credit trade as you are selling the puts and calls options with different strike price but same expiration date.

Advantages and Disadvantages

Advantages:

  • Collect premium from puts and calls options and benefit from double time decay and a contraction in volatility.
  • Higher probability of a profitable trade compare to a Short Straddle strategy due to selling Out of The Money options which has the effect of widening the strike and breakeven point.

Disadvantages:

  • Potentially unlimited loss beyond the breakeven point in either direction if the strike price, expiration date or underlying stock are badly chosen.
  • Limited reward. Lower amount of credit collected compare to a Short Straddle strategy.
  • Higher risk strategy.

Exiting the Trade

  • Close the trade around 50% of maximum profit.

 

When do you sell strangles?

We like to sell Strangles so that we can collect option premium. The high IV entries proved to be the most capital-efficient in terms of overall P/L, win percentage, average P/L per day, and largest single loss. The low IV trades were still successful, but not as attractive as the high IV entries. Since high IV occurrences aren’t nearly as common, we can still be active by mechanically selling strangles in low IV environments, we just have to lower our expectations for these trades.

 

Watch the Study on tastytrade

Strangle study With short strangles being a very common strategy we like to use. We decided to conduct a mega study investigating the strategy’s performance in different volatility environments. For the study, we went back approximately 5 years and sold a 1 standard deviation strangle with 45 days-to-expiration in 5 different underlying on the first trading day of every month. Here are the results:

Strangle study

 

 

 

 

 

 

 

 

 

 

Conclusion trading  Strangles

Trades in a volatile environment provides more profits and opportunities. The average profit per day is higher when you take a profit when you can trade reaches 50% of max profit. And the number of days that you held your position is half of the days than waiting for it to expire. This a strong argument to manage your trade.