What is a short strangle?
A short strangle is a type of options trade. You sell a call option and a put option at the same time, but you sell them "out of the money." This means that the options are sold for a price that is higher than the stock's current price, and lower than the stock's future price.
A short strangle is a strategy that has undefined risk and limited profit potential. The strategy takes advantage of a drop in volatility, time decay, and little or no movement from the underlying asset.
When to use a short strangle strategy
Some traders might use a short strangle strategy when they think implied volatility is too high. This means that they believe that the call and put options are likely overpriced. The trader would then sell these options, wait for the volatility to drop, and close the position at a profit.
Short strangles are market neutral, which means they don't have a directional bias. This type of trade only profits if the underlying stock doesn't move much. When you open this position, you will get credit for it. The risk is unlimited if the stock price moves too far in either direction above or below the strike prices.
How to manage a short strangle position
A short strangle strategy benefits from time decay. This happens because the price of both options you sell declines as time passes. If you choose to close your position prior to expiration, it will be less expensive to buy it back – assuming implied volatility declines.
If implied volatility increases, it can be dangerous for traders who are short strangles. This is because an increase in implied volatility elevates the price of both options you sold. So if you want to close your position before expiration, it will be more expensive to buy back those options.
Short strangle maximum profit potential
The total credit you receive for this trade is your maximum profit.
Short strangle maximum loss potential
When you enter a short strangle, the maximum risk is undefined, beyond the credit you receive.