Legging into a strangle

  • Sometimes traders prefer to “leg” into non-directional options spreads
  • BLNK jumped to high of multi-month range on Monday
  • Call premiums are inflated, put premiums deflated

Trading and investing may seem to boil down to buying something when you think it’s going to trend higher or selling it when you think it’s going to trend lower. But what about when there’s no trend in sight?

One way some traders approach markets they think are more likely to move sideways than up or down is to use a “non-directional” option strategy. For example, say someone thought a stock that had been trading a little above and below $50 for the past several weeks was unlikely to push above $60 or fall below $40 over the next month. In that case, simultaneously selling a $60 call and a $40 put (with the same expiration date) would create a “short strangle” that could profit if the stock continued to trade more or less sideways:

Chart 1: Short strangle risk-reward profile.  Profits from steady stock, falling volatility, and time decay.

Source: Power E*TRADE (For illustrative purposes. Not a recommendation.)

If the stock is still between the two strike prices at expiration, both options would be worthless and the trader would get to keep the premium collected from selling the options. But if the stock moves too much—up or down—the strangle will lose money.

Of course, while this type of strategy is neutral about price direction, it’s not neutral about volatility. In reality, the success of the short strangle relies on an accurate volatility forecast: In addition to the stock moving as little as possible, options volatility also needs to remain stable or decline, since high volatility tends to inflate options premiums, all else being equal.

Unfortunately, the “classic” short-strangle example described above—a rangebound stock, and options strike prices more or less equidistant from the current stock price—doesn’t necessarily present favorable conditions for a strategy designed to benefit from falling options prices. In other words, if you want to sell options high and buy them low, you want to sell them when volatility is high, not moderate to low. And rangebound stocks often have low volatility.

For example, say a trader had recently been watching electric-vehicle charging stock Blink Charging (BLNK)—which, despite tagging a nine-month high when it rallied 17% on Monday, has also been in a broad trading range for almost as long:

Chart 2: Blink Charging (BLNK), 10/14/20–11/16/21. Blink Charging (BLNK) price chart. Top of range.

Source: Power E*TRADE (For illustrative purposes. Not a recommendation.)

As the following chart shows, the stock’s recent upswing (it’s up more than 35% since November 15) dramatically inflated call premiums while letting the air out of put premiums. When the stock was trading around $44 yesterday morning, the $50 call expiring December 10 had quadrupled from where it was on November 4 (and that was after pulling back from Monday’s high), while the $30 put was trading around one-sixth of where it was on November 5:

Chart 3: BLNK $50 call (top) $30 put (bottom), 11/3/21–11/16/21. BLNK options price chart. Calls up, puts down.

Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)

That means a trader thinking about using these options in a short strangle—anticipating a volatility cool-down after the stock’s recent surge—may have been selling the call at a relatively high price, but would have been collecting almost nothing for the short put.

Some traders may think about adjusting this position by selecting a put strike that is closer to the current stock price, which would bring a fatter premium. But that means the stock would need to remain within an even tighter range for the strange to be profitable.

Another approach is to “leg” into the strangle, putting on one half of the trade now and the other half later. For example, a trader who expected a stock like BLNK to pull back after its recent rally—but still remain mostly within its multi-month range—may sell calls as the stock approaches the range highs, while waiting to sell puts (possibly with a more-distant expiration date, to compensate for the delay) after a down move that could increase their value.

Same market outlook, different execution. Like any other technique, it will be more appropriate in some situations than others, but the better you understand a trading strategy’s logic and principles, the better able you’ll be to adjust it effectively for different situations

Today’s numbers include (all times ET): MBA Mortgage Applications (7 a.m.), Housing Starts and Permits (8:30 a.m.), EIA Petroleum Status Report (10:30 a.m.),

Today’s earnings include: Lowe's (LOW), Target (TGT), NVIDIA (NVDA), TJX (TJX), Cisco (CSCO), Bath & Body Works (BBWI), Victoria's Secret (VSCO), Sociedad Quimica y Minera De Chile (SQM).

Today’s IPOs include: Braze (BRZE), Iris Energy (IREN), Sono Group (SEV), UserTesting (USER).


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