The short strangle is a neutral options trading strategy advanced traders employ to profit from low market volatility. By selling both an out-of-the-money (OTM) call and an OTM put with the same expiration date, traders can collect premiums from both sides, expecting the underlying asset to remain within a certain range. This strategy is most effective when there is minimal market movement, as large price swings in either direction could lead to significant losses.
How the Short Strangle Works?
In a short strangle, the trader sells a call option with a strike price above the current market price and a put option with a strike price below the current market price. The premium collected from selling these options represents the maximum potential profit. If the stock price remains between the two strike prices until the expiration date, both options expire worthless, and the trader keeps the full premium.
However, if the underlying asset’s price moves significantly beyond either of the strike prices, the losses can be substantial. The potential loss is theoretically unlimited on the upside (if the stock price rises above the call strike price) and significant on the downside (if the stock price falls below the put strike price).
Example of a Short Strangle Option Strategy
Consider a stock currently trading at ₹1,000. A trader implements a short strangle by selling a call option with a strike price of ₹1,100 and a put option with a strike price of ₹900, both expiring in one month. The trader collects a premium of ₹20 per option, for a total of ₹40.
- Scenario 1: The stock price remains between ₹900 and ₹1,100 at expiration. Both options expire worthless, and the trader keeps the ₹40 premium as profit.
- Scenario 2: The stock price rises to ₹1,150. The call option is exercised, and the trader must sell the stock at ₹1,100, resulting in a loss offset by the premium received.
- Scenario 3: The stock price falls to ₹850. The put option is exercised, and the trader must buy the stock at ₹900, again resulting in a loss.
Success Rate of the Short Strangle Strategy
The success rate of the short-strangle strategy depends heavily on the trader’s ability to predict market stability. In periods of low volatility, this strategy can yield consistent profits due to the premiums collected. However, the risk is substantial during volatile periods, as significant price movements can lead to considerable losses.
Traders often use technical analysis and historical data to assess market conditions before employing the short-strangle strategy. They may also use risk management tools like stop-loss orders or delta hedging to mitigate potential losses.
Short Strangle Options Strategy on Zerodha
Zerodha, a popular brokerage platform in India, provides the tools necessary for implementing the short-strangle option strategy. Through Zerodha’s trading platform, Kite, traders can easily execute and manage their positions.
To set up a short strangle on Zerodha:
- Log in to Kite: Open your trading account on the Zerodha Kite platform.
- Select the Underlying Asset: Choose the stock or index on which you want to implement the short strangle.
- Sell the Call and Put Options: Sell an OTM call option and an OTM put option with the same expiration date.
- Monitor the Position: Regularly check the price movements and be prepared to adjust the position if the market moves significantly.
- Close the Position: Before or at expiration, close the position by buying back the call and put options, ideally at a lower price, to lock in your profit.
Zerodha also offers various tools like the “Sensibull” option chain and strategy builder, which can help traders visualize potential outcomes and manage their trades effectively.
Benefits and Risks of the Short Strangle Strategy
Benefits:
- Premium Collection: The primary benefit is the collection of premiums from both the call and put options.
- Neutral Strategy: Suitable for traders who expect minimal price movement in the underlying asset.
- Flexibility: Can be adjusted or hedged as needed based on market conditions.
Risks:
- Unlimited Loss Potential: On the upside, the potential loss is unlimited, while on the downside, it can be significant.
- Margin Requirements: High margin requirements may apply due to the risk involved.
- Market Volatility: The strategy is highly sensitive to market volatility, and unexpected price movements can result in substantial losses.
Conclusion
The short-strangle option strategy is a powerful tool for experienced traders who understand the intricacies of options trading and are comfortable with the risks involved. By selling both a call and a put option, traders can collect premiums, but they must be prepared for potential losses if the market moves beyond the expected range.
For those trading on platforms like Zerodha, the strategy can be easily implemented with the right tools and analysis. However, it’s crucial to conduct thorough research and use proper risk management techniques to mitigate the inherent risks.
This strategy is not recommended for beginners due to its complexity and potential for significant losses. Instead, beginners should consider starting with more straightforward strategies before exploring advanced options like the short strangle.