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Short Strangle

A Short Strangle is a strategy involving a short call position and a short put position at different strike prices. This strategy results in a net premium received (credit) upon initial order entry based on the current value of the put and call.

Uses

This strategy is normally used when the option trader is neutral through option expiration. The option trader wants to capitalize on little or no price movement. This strategy can also be used when the option trader wants to take advantage of a sudden decrease in implied volatility.

Risks

This strategy is considered to have very high risk and limited reward. The maximum loss does not have a limit and occurs when the stock dramatically decreases or increases away from the current strike prices. The potential maximum gain for this strategy is limited to the net credit initially received for the put and call option.

Price movement is a key component in the value of this strategy. All other risk factors being equal, an increase or decrease in the price of the underlying security will result in a greater loss for the option trader. Neutral activity resulting in the price of the underlying security staying near the strike price may positively affect this strategy.

Volatility can also have a significant impact on this position. All other risk factors being equal, increases in implied volatility have a very negative effect on this strategy. Decreases in implied volatility will have a favorable effect.

In this strategy, time decay is the option trader's friend. A passage in time, all other things being equal, will result in a decrease in option premiums and help the strategy achieve its full profit potential.

Options traders have assignment risk on this strategy. Early assignment (American Style) is a possibility for options, especially if they become in-the-money. Also, the option trader runs the risk of uncertainty on assignment at expiration when the underlying security is hovering around the strike prices. This situation also results in one of the strikes still having some time premium on the last day of trading prior to expiration. The option trader should be aware of these risks prior to implementing this strategy.


Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options.

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