A short strangle is an options trading strategy that involves simultaneously selling an out-of-the-money (OTM) call option and an out-of-the-money put option with the same expiration date on the same Underlying Asset. This strategy profits from the expectation that the underlying asset will not experience significant price movements and will remain within a defined range.
Here's how a short strangle works:
Select an Underlying Asset: Choose the underlying asset (e.g., a stock) on which you want to implement the short strangle strategy.
Determine Strike Prices: Select two Strike prices:
- The call option strike price is above the current market price of the asset.
- The put option strike price is below the current market price of the asset.
Sell Call Option: Sell an out-of-the-money (OTM) call option with the higher strike price.
Sell Put Option: Sell an out-of-the-money (OTM) put option with the lower strike price.
Same Expiration Date: Both the call and put options should have the same expiration date.
Collect Premium: By selling these options, you will collect premiums from the buyers of the call and put options. This premium income is your immediate profit.
Profit and Loss Scenarios:
- Maximum Profit: The maximum profit for a short strangle is achieved if the underlying asset remains within the range defined by the two strike prices at expiration. In this case, both the call and put options expire worthless, and you keep the premiums collected when selling the options.
- Maximum Loss: The maximum loss is theoretically unlimited on the call side if the underlying asset's price increases significantly. On the put side, the maximum loss is also theoretically unlimited if the underlying asset's price drops significantly.
- Breakeven Points: The breakeven points for a short strangle are the strike prices of the call and put options plus or minus the total premium collected.
Management and Adjustment: Traders often monitor their short strangle positions closely and may choose to adjust or close them if they believe the market is moving against their expectations. Adjustments may involve buying back one or both of the options to limit potential losses or rolling the options to different strike prices or expiration dates.
The short strangle is a high-risk strategy because it involves unlimited risk on one or both sides if the underlying asset experiences a significant price move in either direction. It is typically used in neutral or range-bound market conditions when the trader expects low volatility. However, traders should be cautious and have a clear risk management plan in place when using this strategy, as large price movements can lead to significant losses.
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