Understanding
Stock Options Trading
and Technical Analysis Basics

Short Strangle Option Strategy

The Strangle option strategy takes advantages of a stock's volatility or lack thereof. A Long Strangle is ideal for stocks with high volatility, while short strangles are meant for stocks with very little volatility and that stay within tight trading ranges. The strangle position is created by either buying or selling a matching set of call and put options whose strike prices are out-of-the-money.

A Short Strangle option strategy is used when low volatility is expected for the underlying stock. It is created by selling an out-of-the-money (OTM) call option (i.e. a call option whose strike price is above the underlying stock's current price), and selling an OTM put option (i.e. a put option whose strike price is below the underlying stock's price). Both these options have the same expiration date.

The credit premium that you earn by selling these 2 options is your maximum profit for this position. In other words, you earn your profit up front and have to cross your fingers hoping that both these options expire worthless so you do not need to buy them back.

Short Strangle - Sell 1 OTM Put, Sell 1 OTM Call
Short Strangle - Sell 1 OTM Put, Sell 1 OTM Call

The call option that you sell in a short strangle is an OTM call (i.e. a call option whose strike price is above the stock's current price), and the put option is also an OTM (i.e. its strike price is below the stock's current price). Hence for both options to expire worthless and for this position to be profitable, the stock's price must stay in between the 2 strike prices. If the stock's price is below a call's strike price, the call will be worthless. Similarly if the stock is above a put's strike price, the put will be worthless.

Do bear in mind that if you incorrectly predicted the stock's movement and one of the options turn out to be in-the-money, you will need to close the short strangle position by buying up the in-the-money option to prevent it from being exercised. The risk here is high, since the stock could climb or fall very far from your option strike prices, making it very expensive to buy back.

Summary:

The Short Strangle option strategy is a neutral strategy for stocks that do not move much in price. It is created by selling an OTM call and selling an OTM put with the same expiration date. It provides an initial credit premium, which will be your profit if the stock stays within the 2 strike prices. If the stock climbs or falls beyond these strike prices, losses can be unlimited.