A strangle sale is a type of options strategy that involves selling both a call and a put option on the same underlying asset with the same expiration date, but with different strike prices. The strike prices are usually out-of-the-money, meaning they are higher for the call option and lower for the put option.
The purpose of a strangle sale is to collect premium from selling the options and to profit from a neutral or slightly bullish outlook on the underlying asset. A neutral outlook means that the asset price will not move significantly in either direction, while a slightly bullish outlook means that the asset price will rise moderately.
A strangle sale has two break-even points: one at the strike price of the call option plus the net premium received, and one at the strike price of the put option minus the net premium received. The net premium received is equal to the difference between what you receive from selling each option and what you pay for buying them.
A strangle sale has unlimited profit potential if the underlying asset price moves beyond either of the break-even points by more than enough to cover your net premium received. However, it also has unlimited loss potential if the underlying asset price moves beyond either of the break-even points by less than enough to cover your net premium received.
A strangle sale is affected by time decay, which means that as time passes, both options lose value due to their intrinsic value becoming zero and their extrinsic value becoming less attractive. Therefore, a strangle sale becomes more profitable as expiration approaches, as long as volatility remains high or increases.
A strangle sale is a risky but potentially rewarding strategy that can be used by investors who have a neutral or slightly bullish view on an underlying asset and who want to generate income from selling options. However, it also requires careful management of risk and exit strategies to avoid large losses if an unexpected move occurs in either direction.
Basic Theory:
A Strangle is an options trading strategy that involves the sale of both a call option and a put option with the same expiration date but different strike prices. This strategy is typically used when the trader expects significant price movement but is uncertain about the direction. The goal is to profit from increased volatility.
- Call Option Sale: An investor sells a call option with a strike price above the current market price.
- Put Option Sale: Simultaneously, the investor sells a put option with a strike price below the current market price.
Profits are maximized if the underlying asset’s price moves significantly in either direction, while losses are limited to the premiums received from selling the options.
Procedures:
- Identify Market Conditions: Choose a market where you anticipate high volatility.
- Select Strike Prices: Determine strike prices for the call and put options based on your volatility expectations.
- Execute Trades: Simultaneously sell a call option and a put option with the chosen strike prices and the same expiration date.
- Manage Position: Monitor the market and consider closing the position if the underlying asset’s price moves significantly.
Explanation Using Excel:
Excel Table:
| Item | Details |
|---|---|
| Current Stock Price | $100 |
| Call Option Strike | $110 |
| Put Option Strike | $90 |
| Call Premium | -$5 |
| Put Premium | -$5 |
Scenario Calculation:
- Total Premium Received: =SUM(B4:B5)
- Breakeven Points:
- Upper Breakeven (Call): Call Strike + Total Premium Received
- Lower Breakeven (Put): Put Strike – Total Premium Received
- Profit/Loss at Different Prices: Create a table with various stock prices to calculate profits or losses at each level.
- Graphical Representation: Use Excel charts to visualize the potential profit/loss at different stock prices.
Result of the Scenario:
Based on the calculated breakeven points and the profit/loss at different stock prices, you can assess the potential outcomes of the Strangle strategy in this specific scenario.
Other Approaches:
- Adjusting Strike Prices: Depending on market conditions, you can adjust the strike prices to manage risk and potential returns.
- Timing the Market: Consider the optimal timing for executing the Strangle, especially if you anticipate news or events that might impact volatility.
