Short strangle

Article contents



At a glance



Setting up the strategy


  1. Sell one out-of-the-money (OTM) call option on the underlying stock.

  2. Sell one out-of-the-money (OTM) put option on the same underlying stock.
Ideally you want the stock to expire at or between the strike prices, so they expire worthless.

Who should run this?


Advanced traders only.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A strangle is an options strategy in which a trader buys (or sells) one out-of-the money put and one out-of-the money call of the same symbol simultaneously, each with different strike prices, but identical expiration dates.


There are two types of strangles:


Strangle type Description
Long strangle
Used by a trader who thinks the security will experience considerable, short-term volatility.

Gives the option holder the right to buy or sell the stock at the fixed strike prices.

To learn more, see Long strangle.
Short strangle
Used by a trader who thinks the security will experience limited, short-term volatility, or stay stagnant until expiration.

If the options are assigned, the option holder is obligated to buy or sell the stock at the fixed strike prices.

Market outlook


  • Neutral

Strategy benefits


  • Can still profit if the stock price stays stagnant or within a tight trading range.
  • Receive the full maximum profit before expiry when you sell the put and call options, which reduces your risk.

Strategy downsides

  • Potential loss is unlimited if the stock significantly rises or drops
  • Net credit is lower than a short straddle strategy

Short strangle example



Scenario


Let’s say that ABC shares are currently trading at $50 in September. To employ a short strangle, you sell a $43 October put option for $150 and simultaneously sell a $57 October call option, also for $150.
As a result, you will be initially credited $300 from the transactions.

Possible results


  1. At expiration, ABC shares continue to hover around the $50 price point, meaning both the call and put options expire worthless.  Your total profit would be $300.

  2. ABC shares move up 13 points, trading at $63 on expiration, meaning the put option would expire worthless. However, the call option would be assigned and expires in the money. The intrinsic value of the call option would be $600. In this case, you would suffer a $300 loss after subtracting the initial $300 credit you received.

Profit and loss explained



Maximum profit


Maximum profit = option premium received – commissions paid

Maximum loss

When employing a short strangle strategy, significant loss can occur whether the stock moves up or down. Theoretically, if the stock price moves up, your losses could be unlimited.

There are two ways to calculate the maximum loss, depending on the direction of the stock at expiration:

  • Stock value moves upward
    Maximum loss = stock price – strike price of short call – option premium received

    or

  • Stock moves downward
    Maximum loss = strike price of short put – stock price – option premium received

Break-even at expiration

There are two break-even points:

  • Break-even = strike price of short call option + option premium received per share
  • Break-even = strike price of short put option – option premium received per share

Sample calculations



  • Stock value at start of strategy: $50
  • To execute the strategy: Sell $43 put option for $150, Sell $57 call option for $150
  • Result: $300 net credit
Stock price at expiration Profit and loss calculations 
$50 $1.50 (option premium received from put option)
x 100 (number of shares in option contract)
+
$1.50 (option premium received from call option)
x 100 (number of shares in option contract)
= $300 profit
$63 $63(stock price)
-$57 (strike price of short call option)
x 100 (number of shares per option contract)
= $600 loss



Note
: commission fees are not included in the above calculations.


Payoff diagram






Creating a short strangle



 


Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to . Then enter the symbol you want to buy or sell. The default expiration date, strike price, and strategy appear. 




Tip: click the Option tab to view a more detailed option quote.

Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.
Action

The buy or sell action is set for you when you select the strategy type.

Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Order type-specific details
Limit price Enter your limit price:

  • To have the price fluctuate according to real-time data, select . The icon changes to a lock icon , which locks the limit price. Once locked, use the refresh button to automatically update your limit price.
  • To choose a custom price, select .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.






Note: the video tutorial above shows how to create a short strangle strategy using IQ Edge; however, the principles are the same for IQ Web.
Tip: for an optimized viewing experience, watch the video on YouTube in full 720p HD. To open the video in YouTube, click the YouTube button in the bottom right corner of the video window and select the change settings icon to modify the video quality.


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