Learn the basics of a Short Strangle
How can you benefit from a stock that does not move much? You can sell a strangle.
You create a strangle by selling a short call and selling a short put with different strike prices and expiring in the same month.
By selling two options, you significantly increase the income you would have achieved from selling a put or a call alone. A short strangle is established for a credit. We choose option strikes 1 standard deviation away from the current stock price. It means that 68% of the time the stock price stays within that range.
Maximum Loss of a strangle
In theory is the maximum loss is unlimited. The maximum loss occurs if the stock goes to infinity. Or a very substantial loss could occur if the stock became worthless. In both cases the loss is reduced by the amount of premium received for selling the options. Use this strategy only with inexpensive stocks.
Typically we sell Straddles on options with high Implied Volatility so that we receive much option premium. The maximum gain is limited to the premium you have received. The maximum gain occurs if the underlying stock remains between the strike prices. In that case, both options expire worthless and the investor pockets the premium received for selling the options. Underlying (stocks) and options prices are moving much. Winning trades can turn into losers. Therefore we manage winners. As soon as you can make 50% profit close the trade and collect your profit.
If the stock price is either above the call strike price or below the put strike price by the amount of premium received initially. At either of those levels, one option’s intrinsic value will equal the premium received for selling both options while the other option will be expiring worthless.
Upside breakeven = call strike + premiums received
Downside breakeven = put strike – premiums received
We apply the strangle strategy when the underlying has high implied volatility.
The potential profit is limited to the premium received for selling the options. Potential losses are unlimited on the upside and very substantial on the downside.
You increase the probability of profit by managing the trade. As soon as you can make 50% profit you close the trade, collect your profit and redeploy your capital in a new trade.