The Strangle option strategy is a neutral trading strategy that is employed when the trader believes that the underlying asset will stay within a range in the near future. Most all successful traders utilize some form of this strategy regularly to increase their profits and limit their risk.
In this article we are going to cover :
What is a Strangle?
What are the Benefits of Selling a Strangle?
When do we sell a Strangle?
How do we manage a Strangle?
How do we put on a Strangle?
And we will show you using a real example on the TastyWorks Option Trading Platform.
Let’s jump right into it.
What is a Strangle?
A Strangle is an options trading strategy that is utilized when the trader believes that the underlying asset will stay within a range in the near future.
The key to this strategy is selling both an out-of-the-money put and an out-of-the-money call with different strike prices but with the same expiration date.
The trade is profitable if the price of the underlying asset ends up being between the strike prices of the two options at expiration.
What are the benefits of selling a Strangle?
There are some key benefits to selling Strangles.
Strangles allow us to take advantage of time decay. Time decay is the gradual loss in value of an option as it approaches its expiration date. Since we are selling both a put and a call, we are double-dipping on theta or time decay.
As we are selling options, we are collecting premium which gives us a built-in edge from the start. We are selling both sides so we are collecting premium on both sides which increases profit and reduces risk.
We also don’t need the underlying asset to move to make money, it just needs to stay relatively still and within the range of the short strikes.
Lastly, the strangle is easy to manage since there are no protective puts or calls so you just need to roll one option leg.
What are the downsides to selling a Strangle?
As with most things with benefits, there are some downsides that you need to be aware of when selling strangles.
The first is that since we are selling strangles, we are exposed to unlimited risk. This means that if the underlying asset makes a large move in either direction, we could lose a lot of money very quickly.
Selling a strangle with no protective puts or calls can be risky and the rewards of the higher premiums are the tradeoff for the risks.
When should you Sell a Strangle?
The ideal time to sell a strangle is when the IVR (Implied Volatility Rating) is high. When IVR is high, the premium collected will be high as well. Even though IVR is high, we want to put on a strangle when we don’t believe the stock will move much.
I like to look at strangle opportunities after a large drop in a stock. Possibly from missing earnings or some other event. Often the big drop will limit a further big drop and the reason for the big drop will be enough to keep the stock from moving back too high and past the short call side. After a big drop IVR is often still high to allow for a good amount of premium to be collected when the trade is put on.
As with any option strategy, when looking to put on a strangle, we want to make sure that the underlying asset has decent liquidity. This is important because when we sell options, we are selling the right to someone else to buy or sell the underlying asset from us. If there is not enough liquidity, it may be difficult to find someone to take the other side of our trade.
How do we sell a Strangle?
Selling a Strangle is relatively simple. You want to find an underlying asset that you believe will stay relatively still in the near future and has high IVR.
Once you have found the underlying asset, you want to sell a put and a call with different strike prices but with the same expiration date. I like to use options that are about 30-45 days out.
Both options are sold out of the money at about the 30 delta. This allows for a lower chance of being exercised and we can collect more premium.
Now let’s look at how to manage a Strangle position.
How Do We Manage A Strangle?
With premium selling strategies, defensive tactics revolve around collecting more premium to improve our break-even price, and further reduce our cost basis. With short strangles specifically, rolling the untested side (non-losing side) closer to the stock price when the tested side (losing side) is breached is optimal.
At around 21 DTE (Days To Expiration) I look to roll the strangle to the next month or cycle and collect more premium. Adjustments can be made at this time to recenter the strangle. Or if you think the stock will come back within the range the strangle can be maintained at the same strikes when the trade was put on.
When do we close Strangles?
The first profit target is generally 50% of the maximum profit. This is done by buying the strangle back for 50% of the credit received at order entry.
How Do We Lose With A Strangle?
It is very possible to lose when selling a Strangle. The biggest threat to a short strangle is if the underlying asset price moves too far in either direction. If this happens, we can lose a lot of money very quickly. This is why we manage and roll the untested side to collect more premium.
It’s important to remember that with any options selling strategy, there is always the potential to lose money.
Selling A Strangle Example
To better understand how to sell a Strangle, let’s look at an example.
We are going to sell a Strangle in SNAP since it has a high IVR of 69 and has been trading within a range for the past 4 months. We will use the TastyWorks Trade platform. By the way I’ll put the link in the notes below if you want to open an account and get the free stock promotion. It is the option trade platform that I use most of the time and I think it’s the best for trading options.
So we are going to go to the trade tab and punch in the ticker SNAP up above. I like to use the curve mode so that I can visually see the profit zone in green.
We go to the strategy tab and select Short Strangle. The TastyWorks platform will automatically set you up to sell a short strangle.
In this case we are selling the 26 strike put and the 40 call. We collect $249 immediately upon placing this trade. We place the trade with 35 Days To Expiration.
The BP effect which is buying power we are using is $332. So it is a cost-efficient way of investing since are using $332 and collecting $249.
Now if you look at the green area which is the P&L at expiration, we see the max profit is the $249 which is the amount we collected upfront. As long as the stock stays above the 26 put strike and below the 40 call strike price we keep the max profit.
We don’t start losing money until the stock moves below 23.5 or above 42.4. So as long as the price stays between those prices we still profit.
Conclusion
The Short Strangle strategy is a great strategy to use when IVR is high and you think the stock will stay within a range. You can collect high premiums and it is easy to adjust when the stock does move. It is definitely one of my favorite strategies.
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Thanks and see you next time!