Short Strangle Option Trading Explained
The short strangle is an options strategy used by traders who believe the market will remain relatively stable in the near term.
It involves selling both a call option and a put option on the same underlying asset, with different strike prices but the same expiration date. Typically, the call is sold above the current market price, while the put is sold below it.
The appeal of the short strangle is straightforward: it generates income from the premiums received by selling both options:
as long as the underlying asset’s price stays between the two strike prices, the trader keeps the premium as profit. In this scenario, both options expire worthless, which is exactly what the seller wants.
However, the short strangle is not for the faint of heart.
While potential profit is capped at the total premium collected, potential loss is theoretically unlimited.
If the asset makes a sharp move upward, the short call becomes dangerously costly. If it collapses downward, the short put can lead to significant losses as well.
For this reason, traders often use short strangles on assets with low expected volatility, and only when they have a strong conviction that the market will remain calm.
Key points to remember about short strangles:
- Profit potential: limited to the combined premium received.
- Risk: very high, with losses increasing the further the underlying moves beyond either strike price.
- Best used in low-volatility markets or when implied volatility is elevated but expected to fall.
- Requires strong risk management, often paired with stop-loss levels or hedging tactics.
In short, the short strangle is a strategy that bets on boredom. The less the market moves, the better it works. But like most strategies that look deceptively easy, it can quickly punish traders who underestimate how far and how fast markets can shift.