What is a Short Strangle?
The short strangle is similar to the short straddle and does the opposite of the long strangle. The short strangle is a medium to high risk, limited reward, low volatility options strategy. The strategy is to sell short straddle and does the opposite of the long strangle. The short strangle is a medium to high risk, limited reward, low volatility options strategy. The strategy is to sell OTM puts and OTM calls, with the same expiration date but different strike prices, which are equidistant from the current price of the underlying security.
Short Straddle Risk Characteristics
I actually like writing a short strangle due to the large swing that could be tolerated in the price of the underlying before the trade moves into a losing position. It's a good strategy for playing a security that is stuck in a range. I typically sell 1 to 2 months of premium to allow the buyer the least amount of time to make good on the option they have purchased from me. I also make sure that there are no earnings announcements for the duration of the option. While the gains might not be spectacular, the yearly compounded yield can grow quite high.
Risk = Unlimited on when stock moves above or below breakeven points.
The breakeven calculations for the short strangles are the same as for the long strangle.
A short strangle will always have a maximum profit potential equaling the premiums received from selling the strangle.
1) When the security is trading above the put strike and below the call strike, both options that were shorted expire worthless. Profit = put premium received + call premium received
2) Profit/Loss Scenario - Security Moves Higher than Call Strike = Call Premium + Put Premium - Security Closing Price + Call Strike
3) Profit/Loss Scenario - Security Moves Lower than Put Strike = Call Premium + Put Premium - Put Strike + Security Closing Price
Short Strangle Example
Let's use Citigroup (C) to create a straddle example.
Call Option Chain:
Put Option Chain:
Instead of focusing on the long example, let's review how the short strangle would set up with the Citigroup options chain 2 months out of the money. The risk reward is actually very favorable. We would be selling the March 27.5 calls short at $.91 and selling the March 22.5 puts short at $1.01. Now, remember, you will have to have the available funds in your account to cover the potential of the put being exercised against you.
The option premium would have netted you $1.92 and the bet here is that C will stay between $22.50 and $27.50. If this occurs, you will net that entire premium. However, if the tables turn against you and the stock moves out of that range, you have a $1.92 cushion in which you could break even. Therefore, if C is trading between $20.58 and 29.42 in two months, you will walk away unscathed.
Always remember, anything can happen and be prepared if it does. Being short an option is very dangerous if the underlying goes against you dramatically. Remember our discussion on option deltas; once a stock moves above its call strike, the delta starts to increase dramatically and especially so when the stock is closer to expiration. Think about buy stopping the security if it moves above the call strike price. You will at least be able to hedge some of the potential losses. Conversely, if the security would move below the put strike, you may want to consider shorting the stock to offset potential downside risk of the strangle.