Short Strangle

A short stangle is structured one short call option and short a put option with the same expiration, but where the call strike price is above the put strike price.  Typically both options are out-of-the-money.

Market Outlook

Market participants looking for underlying stock to stay range bound over the life of the options.

When to Use

An investor often employs a short strangle if they believe that the underlying will stay range bound and settle between two strike prices by expiration.

Profit & Loss Chart

Benefit

Investors generally initiate a short strangle when they believe that the underlying will remain range bound and would like to capture time premium by selling options . The potential profit is limited to the premium received for selling the options.  Potential losses are unlimited on the upside and very substantial on the downside.

Risk & Reward

Maximum Profit: Limited
Maximum Loss: Unlimited

The maximum gain is very limited. The maximum gain occurs if the underlying stock remains between the strike prices.  In that case, both options expire worthless and the investor pockets the premium received for selling the options.

The maximum loss is unlimited. The maximum loss occurs if the stock goes to infinity, and a very substantial loss would occur if the stock became worthless.  In the first case the loss is infinity, and in the second the loss is the Put strike price; in both cases the loss is reduced by the amount of premium received for selling the options.

Break Even Point

This strategy breaks even if, at expiration, the stock price is either above the call strike price or below the put strike price by the amount of premium.  At either of those levels, one option’s intrinsic value will equal the premium received for selling both options while the other option will be expiring worthless.

Volatility Changes

Increase In Volatility: Negative Effect
Decrease In Volatility: Positive Effect

The effect of an increase in implied volatiltiy, all other things equal, would have a negative impact on a short strangle position due to the fact that their is a greater chance of the underlying making a large enough move over the life of the options. On the other hand, a decrease in implied volatility would have a positive effect on the value of the position. Even if the stock price holds steady, a quick rise in implied volatility would push up the value of both options and force the investor to put up additional margin in order to maintain the position.

Time Decay (Theta)

Positive Effect

The passage of time, all other things equal, will have a very positive impact on this strategy.  Every day that passes without a move in the stock price brings both options one day closer to expiring worthless.