The short strangle, also known as sell strangle, is a neutral strategy in options trading that involve the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date.
Sell 1 OTM Call, Sell 1 OTM Put
The short strangle option strategy is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term. Short strangles are credit spreads as a net credit is taken to enter the trade.
Limited Profit
Maximum profit for the short strangle occurs when the underlying stock price on expiration date is trading between the strike prices of the options sold. At this price, both options expire worthless and the options trader gets to keep the entire initial credit taken as profit.
Net Premium Received - Commissions Paid
Profit achieved when: Price of Underlying is in between the Strike Price of the Short Call and the Strike Price of the Short Put
Unlimited Risk
Large losses for the short strangle can be experienced when the underlying stock price makes a strong move either upwards or downwards at expiration.
Unlimited
Loss occurs when: Price of Underlying > Strike Price of Short Call + Net Premium Received OR Price of Underlying < Strike Price of Short Put - Net Premium Received
Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid
Breakeven points
Strike Price of Short Call + Net Premium Received
Strike Price of Short Put - Net Premium Received
Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a short strangle by selling a JUL 35 put for $100 and a JUL 45 call for $100. The net credit taken to enter the trade is $200, which is also his maximum possible profit.
If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 35 put will expire worthless but the JUL 45 call expires in the money and has an intrinsic value of $500. Subtracting the initial credit of $200, the options trader's loss comes to $300.
On expiration in July, if XYZ stock is still trading at $40, both the JUL 35 put and the JUL 45 call expire worthless and the options trader gets to keep the entire initial credit of $200 taken to enter the trade as profit.
Commissions
These examples exclude commissions and fees. Include all transaction costs when evaluating the profit or loss of a position.
Similar strategies
Long Strangle
The converse strategy to the short strangle is the long strangle. Long strangle spreads are entered when large movement is expected of the underlying stock price.