Strangle Option Strategy

What are the characteristics of this option strategy?

Strangle positions pair an out of the money call and an out of the money put on the same underlying with the same expiration date, and the page below describes the short version, where both contracts are sold. This strategy collects premium, so the maximum profit is limited to the credit received, while the risk is open-ended: the naked short call loses without limit if the underlying rallies, and the naked short put keeps losing all the way down until the underlying reaches zero. It is a neutral strategy: profits are made when the underlying stock or index has limited price movement, and the position loses on a sufficiently large move in either direction.

Is this a bullish, bearish or neutral strategy?

A short strangle is a neutral strategy rather than a directional one. The maximum profit is achieved when the underlying stock or index finishes between the two strikes, and the position loses on a large move in either direction, up or down.

Is this a beginner or an advanced option strategy?

The Strangle Option Strategy is an advanced option strategy. It requires a thorough understanding of the markets and technical analysis to identify a potential range for the underlying stock or index.

In what situation will I use this strategy?

The Strangle Option Strategy is best used when an investor expects the underlying stock or index to remain flat or move within a narrow range. An investor who anticipates significant volatility but is uncertain of the direction should buy a strangle instead. Selling one, as described here, loses money on a large move in either direction.

Where does this strategy typically fall in the range of risk-reward and probability of profit?

A short strangle wins often and loses big. The probability of profit is high, because most of the time the underlying finishes between the two strikes, but the payoff is skewed the wrong way. The premium collected is capped and can look consistent in quiet markets, while a single large move can produce a loss many times the credit received, with no limit on the upside and losses running to zero on the downside.

How is this strategy affected by the greeks?

A short strangle is short gamma, long theta and short vega. Short gamma is what makes it dangerous: as the underlying approaches and then passes a strike, the position picks up delta against the trade and the loss accelerates rather than moving in a straight line. Long theta is the source of the profit, earned only while the underlying stays between the strikes. Short vega means a jump in implied volatility marks the position to a loss immediately, before the underlying has moved anywhere.

In what volatility regime (i.e VIX level) would this strategy be optimal?

Short strangles are usually sold when implied volatility is high relative to the movement actually expected, because that is when the premium is richest for a given distance out of the money. The catch is that high implied volatility is often a correct forecast of a large real move, which is precisely what this position loses on. A rich credit is compensation for that risk, not evidence the risk is small.

How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?

Mechanically the adjustments are simple: roll the tested side out to a later expiration, move the strikes, or close the trade and take the loss. What they do to the risk is less simple. Rolling a losing short strangle usually means selling more time or more contracts to pay for the buyback, which increases the size of the open-ended exposure rather than reducing it. Buying a further out of the money call and put converts the position into an iron condor and is the only adjustment here that actually caps the loss.

Where does this strategy typically fall in the range of commissions and fees?

Two contracts are traded to open and, unless they expire worthless, two more to close, so commissions run higher than a single leg trade but lower than a four leg spread. The larger cost is not commission at all: uncovered short options carry a margin requirement that is marked daily and rises as the underlying moves toward a strike.

Is this a good option income strategy?

Short strangles are often sold for income, and in quiet markets the credits do arrive regularly, but the pattern is misleading. Each month's profit is capped at the credit collected, while a single gap through either strike can cost several times the total taken in over many months. Judge it on the size of the tail, not on the hit rate.

How do I know when to exit this strategy?

The best way to know when to exit the Strangle Option Strategy is to use technical analysis to identify a potential change in the underlying stock or index direction. Once the change is identified, the strategy should be exited before the underlying stock or index hits the strike price of either option contracts.

How will market makers respond to this trade being opened?

A market maker taking the other side of a short strangle is long both contracts and therefore long gamma, and will typically hedge by trading the underlying against the position, buying as it falls and selling as it rises. That is gamma scalping, and it is the mirror image of the risk being taken on. Quoted implied volatility on both strikes will also be marked up when both legs are in demand at once.

What is an example (with calculations) of this strategy?

A short strangle is constructed by selling an out of the money call, say the 60 strike, and an out of the money put, say the 40 strike, with the same expiration date and the underlying trading between the two strikes. For a short strangle the maximum potential profit is the total premium collected, $10 ($6 for the call plus $4 for the put), or $1,000 for one contract of each, realised only if the underlying finishes between 40 and 60 at expiration.

The breakevens sit one credit beyond each strike: $70 on the upside and $30 on the downside. Past those points the position is losing real money. At $80 the short call is worth $20 and the credit covers $10 of it, a loss of $1,000 on a $1,000 credit. At $100 the loss is $3,000, and there is no level at which it stops, because the underlying can keep rising. Below the put strike the loss grows until the underlying reaches zero, where the short put is worth $40 against the $10 credit, a loss of $3,000. Nothing caps either side unless a further out of the money call and put are bought to turn the position into an iron condor.

Bought rather than sold, the same two contracts form a long strangle whose maximum loss is the total debit paid, $10 or $1,000 here, with the same $70 and $30 breakevens working in the trader's favour instead.

MarketXLS – How Does it Help?

MarketXLS offers a comprehensive suite of tools and resources that can help option traders. The easy to use platform includes a variety of calculators and spreadsheets to help traders manage risk and adjust their trades in real-time. MarketXLS also provides trading alerts, back-testing tools and real-time analytics, helping traders make more informed trading decisions.

Here are some templates that you can use to create your own models

Short Strangle Option Strategy
Long Strangle Option Strategy
Calendar Strangle
Strap Strangle
Strip Strangle
Short Straddle Option Strategy
Long Straddle Option Strategy
Strap Straddle
Long Put Synthetic Straddle
Strip Straddle
Calendar Straddle
Synthetic Short Straddle with Calls
Synthetic Short Straddle with Puts
Short Albatross Spread

Search for all Templates here: https://marketxls.com/templates/

Relevant blogs that you can read to learn more about the topic

Long Strangle Option Strategy (Using Excel Template)
Short Strangle Option Strategy
ITM Options: A Strategic Investing Tool
“Maximizing Your Profits with Out of Money Call Options”
Becoming a Pro by Knowing the Option Delta Formula