Short Strangle

A short strangle is an options trading strategy where an investor sells an out-of-the-money (OTM) call option and an out-of-the-money put option on the same underlying asset simultaneously. The call and put options have different strike prices, but both options typically have the same expiration date. This strategy is employed when the trader expects the underlying asset to experience low volatility and remain within a specific price range.

Let's explore a short strangle strategy with an example:

Suppose you're an options trader who believes that NIFTY, currently trading at ₹20000 per share, will remain relatively stable within a certain price range in the next month. You decide to implement a short strangle strategy with the following details:

• Current Stock Price: ₹20000 per lot
• Expiration Date: One month from today

Selling the Call Option (Short Call):

• You sell an out-of-the-money (OTM) call option with a strike price of ₹20400.
• The call option premium you receive is ₹3.25 per lot.

Selling the Put Option (Short Put):

• You sell an out-of-the-money (OTM) put option with a strike price of ₹19600.
• The put option premium you receive is ₹5.9 per lot.

Now, let's examine the potential outcomes of this short strangle:

• Maximum Profit: The maximum profit occurs if NIFTY remains within the range of ₹20400 (the call strike price) and ₹20000 (the put strike price) at the time of expiration. In this scenario, both the call and put options expire worthless, and you keep the entire ₹9.15 per share in premiums (₹3.25 from the call and ₹5.9 from the put) as your profit.
• Maximum Loss: The maximum loss is theoretically unlimited on the upside and limited on the downside. If the stock price makes a significant move in either direction outside of the ₹19600 to ₹20400 range, you will start incurring losses. For example, if the stock price rises above ₹20403.25 or falls below $41, your losses would begin to accumulate.
• Breakeven Points:
  • Upper Breakeven: ₹20400 (call strike price) + ₹3.25 (total premiums received) = ₹20403.25 per lot
  • Lower Breakeven: ₹19600 (put strike price) - $5.9 (total premiums received) = ₹19594.1 per lot

In this example, your short strangle would start incurring losses if NIFTY price moves above ₹20403.25 or falls below ₹19594.1 per lot. As long as the stock price remains within this range, you would profit from the premiums collected. However, significant price movements outside of this range could result in losses.

It's crucial to monitor the position and consider implementing risk management strategies, such as stop-loss orders or adjusting the position, to limit potential losses, especially in volatile markets. Short strangle strategies are used when traders anticipate low volatility and aim to profit from the time decay of the options' premiums.