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Directional Assumption: 

Neutral

A short strangle gives me the obligation to buy the stock at the put strike price and the obligation to sell the stock at the call strike price if the options are assigned. I am wanting the stock price to remain somewhere between the put and call strike so the the options I sell will expire worthless.

When to Run It

I am anticipating minimal movement of the underlying stock.

Setup

  • – Sell OTM Call
  • – Sell OTM Put
  • 70% or greater Probability of Profit

NOTE: Both options have the same expiration month.

Timeline

30-45 days

Ideal Implied Volatility

** 50% or greater**

Implied volatility (IV) plays a huge role in my strike selection with strangles. The higher the IV, the wider my strangle can be while still collecting similar credit to a strangle with closer strikes that are sold in a lower IV environment.

If I choose to keep my strikes closer to the stock price, a higher IV environment will yield a much larger credit, but with less probability as IV is essentially a reflection of the option prices.

Profit Target

Winner : If my position shows a profit near 50% of the max potential gain, I will close the position early to lock in profits.

Loser: I will close the position at 2 x’s the credit recieved if it moves against me.

Time Decay

As time goes by theta works doubly in my favor as I collect premium on both the options that I sold as long as the price stays within the strikes.

Maximum Profit

Potential profit is limited to the net credit received.

Maximum Loss

This is an undefined risk trade since the call and put I am selling are naked. It also takes up more buying power because of the risk.

If the stock goes up, my losses could be theoretically unlimited.

If the stock goes down, my losses may be substantial but limited to the put strike minus the net credit received.

Risk Management

This trade can be scaled up to 1-2% of my account.

Tip

I should consider using strikes that are one standard deviation or more away from the stock price at initiation. That will increase my probability of success. However, the further out-of-the-money the strike prices are, the lower the net credit I will recieve.

Categories: Strategies