Options trading has many ways for traders to make money from stock price movements. One of these ways is the “short strangle.” In this article, we’ll learn about the short strangle strategy, including what it is, when to use it, and the possible risks and rewards. We’ll also look at some examples to make the text more clear.
What is a Short Strangle?
A short strangle is a way to make money in options trading. It involves selling a call option and a put option on the same stock with the same end date. The goal is to make money if a stock stays within a certain price range until the options end.
Example:
Imagine a stock called ABC is trading at $50. You think the stock price won’t change much in the next month, so you set up a short strangle. You sell a call option with a strike price of $55 and a put option with a strike price of $45, both with an end date one month away.
When to Use a Short Strangle
Use the short strangle strategy when you think a stock will not change much in price. This strategy can make money if the stock price stays between the call and put options’ prices.
How to Set Up a Short Strangle
To set up a short strangle, follow these steps:
- Choose a stock that you think won’t change much in price.
- Pick an end date for the options.
- Sell a call option with a price above the current stock price.
- Sell a put option with a price below the current stock price.
When you sell the call and put options, you get money from the buyers. This money is the most you can make if the stock price stays between the option prices until they end.
Example:
Let’s go back to the ABC stock example. You sell the $55 call option and the $45 put option for $1 each. You receive $200 total since each option represents 100 shares ($1 x 100 shares x 2 options).
Potential Risks and Rewards
The rewards of a short strangle can only be the money you get from selling the options. But, the risks can be big if the stock price changes a lot.
Rewards
The most money you can make is when the stock price stays between the call and put options’ prices. In this case, both options end with no value, and you keep all the money you got.
Example:
In our ABC stock example, if the stock price stays between $45 and $55 until the options expire, both options become worthless, and you keep the $200 premium you received.
Losses
You can lose money if the stock price changes a lot. If the stock price goes up a lot, you may have to buy the stock at a higher price to cover the call option. If the stock price goes down a lot, you may have to buy the stock at a lower price to cover the put option.
Example:
If the ABC stock price goes up to $60, you’ll have to buy the stock at $60 to cover the call option and sell it to the call option buyer for $55. This would result in a loss of $5 per share, minus the $2 premium you received, for a total loss of $3 per share.
Managing the Short Strangle
It’s important to watch and manage a short strangle to keep from losing a lot of money. Here are some ways to do this:
Change the position: If the stock price gets close to one of the option prices, you can change the position by
moving the options to a different price or end date. 2. End the position: If the stock price changes a lot, you can end the position by buying back the call and put options you sold. This can help you lose less money.
Protect the position: You can protect a short strangle by using other options strategies, like buying a call option with a higher price or buying a put option with a lower price. This can help keep your investment safe if the stock price doesn’t do what you thought it would. (Example: In the ABC stock example, if the stock price moves close to $55 or $45, you can roll the options to a different strike price or expiration date to reduce the risk. If the stock price moves to $60, you can buy back the call option and sell a new call option with a higher strike price, like $65. This will help you manage the risk and potentially limit your losses.
Conclusion
The short strangle is a cool options trading strategy that can make money when a stock doesn’t change much in price. It involves selling call and put options on the same stock with the same end date. The most money you can make is the money you get from selling the options, but the risks can be big if the stock price changes a lot. By watching and managing the position, you can try to keep from losing money and have a better chance of making money. The examples provided help illustrate how the strategy works and how to manage it for the best results.
FAQs
How risky is a short strangle?
A short strangle can be risky if the stock price changes a lot. You could lose a lot of money if the stock goes up or down too much. But if you manage the position well, you can lower the risk.
Is short strangle always profitable?
No, a short strangle isn’t always profitable. You can make money if the stock price stays between the call and put options’ prices. But if the stock price changes a lot, you could lose money.
What are the benefits of a short strangle?
The benefits of a short strangle are that you can make money if a stock’s price doesn’t change much. You also get money from selling the options, which is the most you can make if the stock price stays between the option prices.
Is a short strangle bullish or bearish?
A short strangle is neither bullish nor bearish. It’s a neutral strategy because it makes money when the stock price doesn’t change much.
What is the winning probability of a short strangle?
The winning probability of a short strangle depends on the stock price staying between the call and put options’ prices. It’s hard to give an exact number, as it depends on the stock and the option prices.
Which is better short strangle or straddle?
Both short strangle and straddle have their pros and cons. A short strangle can make more money if the stock price doesn’t change much, but a short straddle can make money if the stock price changes a lot. Choose the strategy based on your view of the stock price movement.
Which is safer straddle or strangle?
A straddle can be safer than a strangle because it can make money if the stock price changes a lot. However, both strategies have risks, so it’s important to manage the positions well.
How do you manage short strangles?
To manage short strangles, you can change the position if the stock price gets close to the option prices, end the position if the stock price changes a lot, or protect the position by using other options strategies.
Is selling strangles profitable?
Selling strangles can be profitable if the stock price stays between the call and put options’ prices. However, there are risks if the stock price changes a lot.
What is the maximum loss on a strangle?
The maximum loss on a short strangle is unlimited if the stock price goes up a lot. If the stock price goes down a lot, the maximum loss is the difference between the stock price and the put option’s strike price.
When should you do a short strangle?
You should do a short strangle when you think a stock’s price won’t change much. This strategy can make money if the stock price stays between the call and put options’ prices.
What is the disadvantage of a short strangle?
The disadvantage of a short strangle is the risk of losing money if the stock price changes a lot. It’s important to manage the position well to lower the risk.
What is the difference between a short strangle and an iron condor?
A short strangle involves selling a call and put option on the same stock, while an iron condor involves selling and buying both call and put options at different strike prices. An iron condor has limited risk and reward, while a short strangle has unlimited risk if the stock price goes up a lot.