What is a Short Strangle? – Options Trading Strategy Explained

What is a Short Strangle?

The Short Strangle is an options selling strategy where you sell both a Call and a Put option at different strike prices but with the same expiration date. The goal is to profit from the premiums collected from selling these options, while hoping that the market stays within a certain range.

Here’s a breakdown:

1. 1. Sell a Call Option:
      • • You sell an out-of-the-money (OTM) call option, meaning the strike price of the call is higher than the current market price.
        • You profit if the price stays below this call option’s strike price.
   2. Sell a Put Option:
      • • You sell an out-of-the-money (OTM) put option, meaning the strike price of the put is lower than the current market price.
        • You profit if the price stays above this put option’s strike price.

What is the Goal of a Short Strangle?

The goal is for the market to stay between the two strike prices (the call strike and the put strike). If the market doesn’t make a big move in either direction, both options will expire worthless, and you get to keep the premium you collected from selling them.

• • Profit: Comes from the premiums collected for selling both options.
  • Risk: If the market moves beyond either strike price (above the call strike or below the put strike), your losses can be unlimited (on the call side) or substantial (on the put side).

When to Use a Short Strangle?

You would typically use a Short Strangle strategy when you expect the market to be range-bound (not moving much in either direction) and relatively stable. This means you believe the price of the asset will stay between the strike prices of the two options you’ve sold.

• • Example: If Nifty is trading at 18,000, you might sell a 19,000 Call and a 17,000 Put, collecting premiums for both. If the market stays between 17,000 and 19,000, both options expire worthless, and you keep the premiums

Profit Potential and Risk:

Maximum Profit:
The maximum profit is limited to the total premium collected when you sold the call and put options.

• • For example, if you sold the 19,000 Call for ₹100 and the 17,000 Put for ₹100, your total premium collected is ₹200. This is the maximum profit you can make if Nifty stays between 17,000 and 19,000 at expiration.

Maximum Loss:
The potential loss is unlimited if the market makes a big move in either direction.

• • If the market goes above 19,000, the call side will generate losses (since you are obligated to sell at the lower strike price).
  • If the market goes below 17,000, the put side will generate losses (since you are obligated to buy at the higher strike price).

Example:

Let’s assume Nifty is trading at 18,000.

You execute a Short Strangle by:

1. 1. Selling a 19,000 Call for ₹100.
   2. Selling a 17,000 Put for ₹100.

• • You collect ₹200 as the total premium.

Scenarios:

If Nifty stays between 17,000 and 19,000 at expiration:
Both options will expire worthless, and you keep the ₹200 premium as your profit. This is the ideal outcome.

If Nifty goes above 19,000 (say, 19,500):
The 19,000 Call will be exercised, and you will need to sell Nifty at 19,000 while it’s trading at 19,500. This results in a loss of ₹500 per unit.

• • Your total loss = ₹500 (loss) – ₹200 (premium) = ₹300 loss per unit.

If Nifty goes below 17,000 (say, 16,500):
The 17,000 Put will be exercised, and you will need to buy Nifty at 17,000 while it’s trading at 16,500. This results in a loss of ₹500 per unit.

• • Your total loss = ₹500 (loss) – ₹200 (premium) = ₹300 loss per unit.

Advantages of a Short Strangle:

Profit from time decay: You earn money as time passes because the value of options decreases as expiration approaches.

Double premium: Since you are selling both a call and a put, you collect two premiums at once.

Ideal for range-bound markets: Works best in markets where price movements are limited, so both options expire worthless.

Disadvantages of a Short Strangle:

Unlimited risk on the call side: If the market goes far above the call strike, your losses can be significant.

Trick and Technique To Avoid Unlimited Losses from Short Strangle

High margin requirement: You need a large margin to cover the risk of this strategy, especially because of the naked call and put exposure.

Less suitable for volatile markets: If you expect big moves in the market, this strategy can be very risky.

In Summary:

A Short Strangle is a great strategy if you expect the market to stay within a range and want to profit from time decay by collecting premiums from both a call and a put. However, it carries significant risk if the market moves sharply in either direction, so risk management is crucial.