Getting started with short strangle strategy for beginners 

Nowadays, options trading is quite popular among traders. It is a financial instrument that has no inherent worth but instead derives its value from the underlying security, which can be stocks, exchange-traded funds, indexes, etc. With this instrument, you can buy or sell contracts based on the contract you hold. 

However, to become successful in options trading, it is essential to learn about various strategies. One such strategy that we will discuss here is the short strangle. Let’s start.

What is short strangle option strategy?

The short strangle option strategy is used when you expect an underlying stock to stay within a specific price range. It involves selling a call option and a put option on the same stock, with both options being out of the money—that is, the call option’s strike price exceeds the stock’s spot price, and the put option’s strike price is lower. 

You earn money from the premiums paid for these options. If the underlying stock price stays between the two strike prices until the options expire, you can keep the premiums as profit. 

However, if the underlying stock price moves considerably in either direction, you could face unlimited losses because the contract buyer could exercise one of the options, compelling you to buy or sell the stock at a loss. 

How does the short strangle strategy work?

Let’s take a short strangle option example in a step-by-step guide to understand how this approach works. 

• Step 1: You select an underlying stock, Reliance Industries Limited (RIL), currently trading at Rs 2,000. The current price is known as the spot price. 
• Step 2: You sell a call option with a strike price above the spot price, say Rs 2,100, expecting RIL to stay below this price. You receive a premium, for example, Rs 50.
• Step 3: Simultaneously, you sell a put option with a strike price lower than the prevailing price, say Rs 1,900, expecting RIL to stay above this price. You also receive a premium, let’s assume Rs 60.

You have collected a total premium of Rs 110 (Rs 50 + Rs 60). This is your maximum potential profit.

Scenario Analysis:

• RIL Stays Stable: As long as the price of RIL stays between Rs 1,900 and Rs 2,100 until expiration, both options will be worthless, allowing you to keep the entire premium of Rs 110 as a profit.

• RIL Rise Above Rs 2,100: If RIL rises above Rs 2,100, the call option may be exercised. However, as long as the price doesn’t exceed Rs 2,210 (Rs 2,100 + Rs 110 premium), you won’t face a loss.

• RIL Falls Below Rs 1,900: If RIL falls below Rs 1,900, the put option may be exercised. Similarly, as long as the price stays above Rs 1,790 (Rs 1,900 – Rs 110 premium), you are safe from losses.

Risks:

• Unlimited Loss Potential: If RIL makes a significant move in either direction beyond the breakeven points, you could face substantial losses.

• Margin Requirements: Since the potential loss is unlimited, you will need sufficient margin in your account to cover the risk.

Breakeven Points:

• Upper Breakeven: Strike Price of Call + Premium Received = Rs 2,210
• Lower Breakeven: Strike Price of Put – Premium Received = Rs 1,790

Tips for implementing short strangle strategy

Here are some tips to consider when using the short strangle option strategy. 

• Before setting up a Short Strangle, assess the market volatility. It is a good time to sell options if you expect low volatility. For example, if the Nifty is at 17,000 points, you might sell a 17,500 call and a 16,500 put.

• Select strike prices far enough from the current price to provide a cushion. Suppose Reliance shares are trading at Rs 2,000; you could sell a Rs 2,100 call and a Rs 1,900 put.

• Trade in options with high liquidity to ensure you can enter and exit positions easily. 

• Check your positions regularly. If the underlying security of your option is nearing its strike price, be ready to take action.

• Decide in advance the profit or loss at which you will close the position. You may decide to exit after earning a 20% profit on the premium received.

• Since a Short Strangle requires margin, use it wisely. Don’t over-leverage your capital.

• If the market moves against you, adjust the trade. You could buy back the threatened option and sell another with a more distant strike.

• Keep an eye on events like earnings reports or economic data releases that can cause volatility. Avoid setting up a Short Strangle before the quarterly results of the underlying stock if you are not prepared for potential swings.

• Options lose value over time, which benefits the Short Strangle. Sell options with about 30 days to expiration for optimal time decay.

• Diversify Your Trades, and don’t put all your money in one security. 

• Be aware of the tax rules regarding options trading in India to manage your finances effectively.

• Maintain a log of your trades to analyse performance. Note down the details when you set up a Short Strangle in any share.

• Only invest that much capital you can afford to lose. If you are selling a Rs 10,000 premium, ensure it is not your emergency fund.

• Don’t rush to close your position at the first sign of movement. Give the market time to prove your strategy right.

Conclusion 

In conclusion, the short-strangle options strategy offers traders a versatile approach. It allows you to profit from stable market conditions. By selling out-of-the-money call and put contracts, you can generate profit while managing risks. However, it is crucial to monitor positions closely and be ready to adjust strategies as needed to mitigate potential losses. To learn more about options trading, subscribe to StockGro!

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