A short strangle is a position that is a neutral strategy that profits when the stock stays between the short strikes as time passes, as well as any decreases in implied volatility.
The short strangle is an undefined risk option strategy.
Directional Assumption: Neutral
- Sell OTM Call
- Sell OTM Put
Ideal Implied Volatility Environment : High
Max Profit: Credit received from opening trade
How to Calculate Breakeven(s):
- Downside: Subtract total credit from short put
- Upside: Add total credit to short call
With strangles, it is important to remember that we are working with truly undefined risk in selling a naked call.
We focus on probabilities at trade entry, and make sure to keep our risk / reward relationship at a reasonable level.
Implied volatility (IV) plays a huge role in our strike selection with strangles. The higher the IV, the wider our strangle can be while still collecting similar credit to a strangle with closer strikes that is sold in a lower IV environment.
If we choose to keep our strikes closer to the stock price, a higher IV environment will yield a much larger credit, as IV is essentially a reflection of the option prices.
Our target timeframe for selling strangles is around 45 days to expiration. Our studies show this is a great balance between shorter and longer timeframes.
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.
When do we defend strangles?
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, we have shown through our studies that rolling the untested side (non-losing side) closer to the stock price when our tested side (losing side) is breached is optimal.