Short Strangle Options Strategy (Best Guide w/ Examples)

[Music] hey everyone Chris here from Project option and in this options trading strategies video we're going to talk about a directionally neutral options trading strategy called the short strangle now the short strangle consists of selling a call and put option on a stock and in this strategy you profit when they stock price remains within a specific range so in this video we're going to talk about the short strangle strategy characteristics we're going to look at an expiration risk profile graph for the strategy and then we're going to look at three real strangle trades to show you how the strategy performs as the stock price changes through time so let's get started with the strategy characteristics so selling strangles is a neutral strategy that consists of selling an out of the money call and put in the same expiration cycle traders implement the strategy when they believe a stock will remain in a specific range now that's because if the stock price remains between your short strikes between your your short call and your short put then as time passes those options will decrease in value leading to profits for your position now if the stock price is between your short strikes when the options expire those options will be worthless and you'll cook you'll keep the entire credit that you collected when you sold the strangle so the maximum profit potential when selling a strangle is the credit received times 100 so if you sell a strangle for a $5 credit your maximum profit is $500 now since the short strangle includes a short call option that is not covered by long stock or a long call option there is unlimited loss potential on the upside for this strategy now that's because there's no limit to how much a stock can increase and if you're short a call option if the stock price increases indefinitely you'll have unlimited losses in theory now the break-even prices of a short strangle are going to be the short call strike price plus the credit you receive and the short put strike price minus the credit you Seve so that credit you receive actually widens your breakeven points beyond your short call and short put strike prices now the estimated probability of profit for a short strangle position really depends on the short call and short put that you sell so typically you could have a probability of profit anywhere between 50% and 99% depending on the options you sell so the further out the options that you're selling the higher your probability of profit will be but you'll also have less potential reward because you're going to be selling cheaper and cheaper options so there's a balance between the probability of profit and the amount of potential reward that you'll have for a short strangle now we'll go into that a little bit more detailed in a little bit now after expiration you can have a resulting stock position if one of your options is in the money so if your short call expires in-the-money then you'll be assigned negative 100 shares of stock per short call contract which essentially means you'll have a short stock position of a hundred shares of stock per call now if your short put is in the money at expiration you'll be assigned 100 shares of stock per short put which means you'll basically be buying a hundred shares of stock at the short puts a strike price if it expires in-the-money now in regards to assignment risk if the short call is in the money before expiration you have the potential to be assigned negative 100 shares of stock per call contract and if your short put is in the money before expiration you have the potential to be assigned plus 100 shares per put contract so if you one of your short options is deep in the money before expiration there is the potential to be assigned on those options so now let's go ahead and take a look at a hypothetical short strangle position constructed from the following option chain so at the time of these option prices let's say the stock price is trading at $200 and we believe the stock price is going to remain between 190 and 210 so a 5% move up or down so what we can do is we can sell a strangle on the stock so in this example we're gonna sell the 190 put for three dollars and seventy eight cents and we're going to sell the 210 call for four dollars and 31 cents which will give us a net credit of eight dollars and nine cents so based on this trade let's go ahead and take a look at the expiration risk profile graph alright so as we can see this is the risk profile graph for this short strangle at expiration so the first thing we want to pay attention to is the middle portion of the graph which represents where we realize maximum profit so as I said before if the stock price is between your short call and short put strike at expiration both of the options that you sold will expire worthless and you'll keep the entire credit that you receive for selling the strangle so in this example we sold the 190 put in 210 call for a total credit of 8.9 cents now that means in actual dollar terms our maximum profit potential on this trade is eight hundred and nine dollars so based on this graph we can see that if the stock price is between 190 and 210 at expiration we will have a profit of eight hundred and nine dollars at expiration now let's go ahead and look at our breakeven prices so our breakeven prices are going to be the short put strike price minus the credit received and the short call strike price plus the credit we received so that brings our breakeven prices to one 8191 and to 1809 so essentially this means that if the stock price remains between 180 191 and to 1809 we will make money on this trade now if the stock price is right at one of our breakeven prices then that means one of our short options will be worth the the same amount that we sold the strangle for at expiration in which case we won't make any profits or losses if you look at any significant stock price decreases or increases you'll notice that we have significant lost potential on a short strangle strategy so in this case if the stock price Falls to 140 we'll have a loss of around $4,000 per contract and if the stock price rises to around 260 we'll also have a loss around 400 $4,000 per contract or per short strangle so we need to keep in mind of the short strangle strategy is that while it's a very nice strategy to have because it profits when a stock price remains in a certain range you have to keep in mind that if the stock price you know explodes out of that range you have significant loss potential especially on the upside so while a short strangle has a high probability of making money when it loses money and has the potential to lose a lot so you have to have a very strict management plan for this strategy so now that you've seen the expiration risk profile graph let's go ahead and take a look at the option Greek exposures for a short strangle strategy to help you understand how it can profit or lose money before expiration all right so let's talk about Delta Gamma theta and Vega as they relate to a short strangle position so in terms of Delta the Delta really varies because you know you could structure a short strangle to be completely Delta neutral or a delta near zero as you initiate it but you can also structure a short strangle to be slightly directional so for example if you sell a 20 Delta put in a 10 Delta call you'll actually be net long because you sold a you sold a put with a higher Delta than the call you sold so that leaves you net long Delta's so while a short strangle is generally a neutral strategy you can definitely structure in a directional way by selling a collar put option that has a higher Delta than the opposing side now in regards to gamma a short strangle position has negative gamma now that means that as the stock price rises a short strangle position becomes more short and when the stock price falls a short strangle position becomes more long so if the stock price keeps increasing towards your short call you're going to get more and more bearish on your position which means that you're gonna have negative deltas now a negative Delta means that if the stock price keeps increasing you're gonna lose more and more money as it does so what you want to happen here is you want the stock price to remain between your short strikes and you do not want it to make a run to either direction as that will make you more and more long or more and more short and you'll lose more money if that move continues so in regards to theta a short strangle position has positive theta now that means that as the extrinsic value of options decays over time this leads to profits for a short strangle holder now that's because as a strangle seller you want the options that you sold to decrease in price and since deep options decrease in price as time passes you have a positive theta value on your short strangle which means that you profit from the passage of time now lastly in regards to Vega a short strangle position has negative Vega now that is because an increase in implied volatility indicates an increase in option prices which is not good for strangle sellers so when you sell a strangle you are selling options and anytime you sell options you want those options prices to decrease from the point that you sold them so when implied volatility increases that indicates that option prices are becoming more expensive which naturally will lead to losses for a strangle seller now on the other hand decreases in implied volatility indicate that option prices are falling which is obviously a very good thing for strangle sellers so when we put all these Greeks together we learned that a short strangle position profits from the passage of time when the stock price is between the short call and short put strikes and any decreases in implied volatility now on the other hand a short strangle loses money if implied volatility increases or if the stock price makes an explosive move in either direction so for a short strangle position to work out you need the stock price to remain relatively calm and you want it to remain between your short strikes because you'll make money from the passage of time and you'll also be able to make money if implied volatility decreases so now that you know the theory behind a short strangle position let's go ahead and look at three real trade examples to show you how the position performs in various scenarios so the first example we're going to look at is where a trader realizes the maximum profit potential on a short strangle position which of course happens when the stock price is between the short call and short put strikes at expiration so here's the setup the initial stock price at entry is two hundred and twelve dollars and forty four cents and the initial implied volatility is fourteen percent now the strike prices we're going to use are the 201 put and the 219 call that expire in 63 days now at the time of selling these options will collect a net credit of two dollars and fifty eight cents because we'll be selling the put for one dollar and seventy five cents and the call for 83 cents now our breakeven prices for this trade will be 220 158 and 190 842 and that just comes from the short call strike plus the credit and the short put strike minus the credit now our maximum profit potential in this case is the credit of two dollars and fifty eight cents times 100 which is two hundred and fifty eight dollars so let's go ahead and take a look at how this position performs as time passes and the stock price changes alright so as we can see here on the top part of the graph we're looking at the changes in the stock price relative to the short call and short put strike prices and also the break-even prices of the strategy so as we can see here this position worked out perfectly and the stock price remained between the short call and short put strikes all the way through expiration now on the bottom part of the graph we can see the price of the strangle through time so when we enter the strangle it was trading for a net credit of two dollars and fifty eight cents and as we can see the value of that strangle dwindled away as time passed and at expiration the position was worth zero dollars so for selling the strangle for two dollars and fifty eight cents since it expired worthless this would real day profit of two hundred and fifty eight dollars per short strangle all right in this next example we're gonna look at how a short strangle performs when the stock price collapses so obviously that's not a good thing so here's the setup the initial stock price is five hundred and twenty four dollars and initial implied volatility is twenty six percent the short strangle strikes we're going to use are the four ninety five put and five fifty five call expiring in thirty nine days now we're going to collect a net credit of 12.55 cents for this position and our breakeven prices are going to be four eighty two forty five on the downside and 567 fifty five on the upside now the maximum profit potential in this case is the twelve fifty five credit times 100 which comes out to one thousand two hundred and fifty five dollars now as always the maximum loss potential is unlimited so let's go ahead and see what happens to this short strangle position as the stock price decreases alright so again and the top part of the graph we're looking at the changes in the stock price relative to the short call and short put strike prices and we're also looking at the breakeven prices now on the bottom part of the graph we're looking at the strangles price and any corresponding profits or losses we have relative to that price so in the top part of the graph we can see that the stock price actually remains right around five hundred twenty-five dollars for you know the first week or so and then the stock price actually collapses to around four hundred and sixty dollars which is well below our short put strike price of 495 now when that happens we can see that the straddle or the Stranglers price increases to around forty eight dollars now since we sold it for around $12 when the Stranglers price reached $48 we're actually sitting on a loss of $36 per short strangle which equates to a thirty six hundred dollar loss per strangle so as I said before a short strangle position is highly risky and has significant loss potential on the downside and the upside if the stock price makes a large move so you really need to pay attention to you know your your management strategy for that position now in this case fortunately the stock price rallied back up in between the short strikes and the position did expire worthless at expiration so if you would have sold this strangle and held it to expiration you would have made the full profit again but it was a very uncomfortable ride because you did have that large loss at one point when the stock price fell to around 460 dollars so this example just really demonstrates how you really have a lot of risk when you're selling a strangle because if the stock price makes an outsized move you're gonna have a very very painful trade so now in this next slide we're actually going to look at how the position Delta of the short strangle changes as the stock price changes because that'll help you understand what that negative gamma means all right so in this graph we're actually looking at the same thing on the top graph so we're just looking at the changes in the stock price relative to the short call and short put but on the bottom part of the graph we're looking at the position Delta which is the combined Delta of the short call and short put multiplied by 100 so the lowest that the position Delta for one strangle can be is negative 100 which represents a short stock position of 100 shares and the most the position Delta can be is plus 100 which represents a position of plus 100 shares of stock or owning a hundred shares of stock so as we can see in this example the stock price remains relatively flat over that first week or so but then really collapses to around 460 dollars now at the same time we can see that the position Delta of this short strangle gets more and more long as the stock price is decreasing so initially when we put the strangle on the position Delta was right around zero which means we really didn't have any directional exposure to changes in the stock price now as the stock price fell to 460 dollars the position Delta rose to about 70 plus 70 so what that means is that when the stock price was at 460 and our position Delta was plus 70 that means we essentially had exposure of a long stock position of 70 shares so if the stock price fell by $1 we would lose 70 dollars from that directional move and if the stock price increased by $1 we would make 70 dollars from that directional move so this just really shows that if the stock price decreases significantly a short strangle position will become more and more long which means that if the stock price continues to decrease you're going to lose more and more money from that directional movement so while a short strangle starts directionally neutral in most cases it can definitely become a very directional position all right so in this last position we're going to look at a partially profitable strangle which basically means that the stock price expires beyond one of the short strikes but not enough to make the trade unprofitable so here's the setup the initial stock price is 108 29 and we're going to sell the 103 111 strangle expiring in 44 days now for this position we're going to collect a credit of 3 dollars and 22 cents and that's going to bring our breakeven prices to 99 78 on the downside and 114 22 on the upside so a pretty wide range there so our maximum profit potential is going to be the credit of 3 dollars and 22 cents times 100 which comes out to 322 dollars now as always our maximum loss potential is unlimited all right so in the top part of this graph we're looking at the changes in the stock price relative to the short call short put and the break events of the strategy so as we can see here the stock price Falls from its initial entry price of 108 29 and at expiration it is between the short put strike price of 103 and the lower breakeven of 99 78 so since this option since the short put is in the money at expiration that means that the short put expires with intrinsic value which means we don't make full profit on this trait to make full profit on a short strangle you need both options to expire completely out of the money and in this case the short put expires just slightly in the money however since this since the stock price is still above the lower break-even price of 99 78 the trade is still profitable so in this case the short put has a value of about a dollar and 50 cents at expiration and as we can see there the short strangle at expiration is worth about a dollar 50 so that makes sense so since we saw hold the position for $3.22 and at expiration it was only worth a dollar 50 then in this case we would have a profit of one dollar and 72 cents or a hundred and seventy to seventy two dollars per short strangle position now since the short put expired in the money keep in mind that if you held that position through expiration and you do not close the short put you would be assigned a hundred shares of stock per short put contract so whenever you have an in the money short option at expiration you need to close that option before expiration if you do not want a stock position all right so let's go ahead and recap the main concepts that you've learned from this video so first and foremost selling strangles is a directionally neutral strategy that consists of selling an out of the money call and put in the same expiration cycle now while it's typically entered as a directionally neutral trade recall that we did mention that you can structure it in a directional manner but most of the time it will be a directionally neutral position now the main profit drivers of the short strangle strategy are the passage of time because the position has positive theta and decreases in implied volatility because the position has negative Vega now to close a short strangle before expiration you can just buy back the short call in short put at their current prices to lock in profits or losses on the position so the stock price explodes in either direction and you don't want to you know you don't want to deal with that risk and you want to close the position for a loss you can just buy back the strangle on the other hand if the strangle DK is in price and say it's worth you know 50% of what you sold it for and you want to lock in those profits you can just go ahead and buy that strangle back before expiration and you'll successfully lock in your profits now due to having significant loss potential and limited profit potential the short strangle strategy has a high probability of profit so just keep in mind that even though it has a high probability of profit that stems from the fact that it has a limited profit potential and theoretically unlimited loss potential now though the strategy begins delta-neutral most of the time the position will become very directional if the stock price trends in one direction now that's because the strategy consists of a short call in short put and it also has negative gamma so as the stock price increases the short strangle position will become more bearish because it'll have negative deltas and if the stock price decreases the short strangle position will be get more long because it'll have positive deltas so keep in mind that even though it is a directionally neutral trade as the stock price changes it will become directional thank you so much for watching this video everybody I hope you enjoyed it if you did please go ahead and subscribe to our YouTube channel as you'll receive all of our new YouTube content as we release it 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Channel: projectfinance

Views: 26,750

Rating: 4.948936 out of 5

Keywords: short strangle option strategy, short strangle strategy, strangle option strategy, short strangle options, short strangle, selling strangles, option strategies, projectoption, selling options, options trading, stock market, implied volatility, options trading for beginners, option trading strategies, selling premium, short call, short put, options trading strategies

Id: r-lX2M3EgFc

Length: 22min 40sec (1360 seconds)

Published: Tue Mar 14 2017