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Short Strangle
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| Risk: |
Limited |
| Reward: |
Limited |
| The Trade: |
Sell out of the money calls and puts |
ABC Stock trading at £5.00
Sell 1 Sep £5.50 call and sell 1 Sep £4.50 put (see pay-off diagram below)
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| When to use: |
You believe the stock will move in a range or sideways type price action. This strategy is similar to selling a Straddle but the premium received is smaller. But then a larger move either way is needed to show a loss.
Which options to sell (or how far away from the underlying price) depends on what type of range you expect. Expecting a tight range, nearer the money. Expecting a wide range then further out-of-the-money.
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| Volatility expectation: |
Very bearish, a decrease in volatility will work marvels for the position. |
| Profit: |
The profit potential is limited but a substantial and sudden move can turn this trade into a big loser especially if one of the sold options goes 'into the money'. But generally considered as a more cautious trade than a 'Short straddle'. |
| Loss: |
Unlimited for a sharp move in the underlying in either direction. |
| Breakeven: |
Occurs if the underlying expires below strike A or above strike B by the same amount as the premium received in establishing the position. |
| Time decay: |
This position is a big wasting asset therefore time decay helps enormously. But if volatility increases, erosion slows, if volatility decreases, erosion speeds up. |
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Trading ideas and tactics:
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- Can mix the strikes up depending on whether you lean towards the bull or bear tract but are still overall neutral - Perhaps you feel the odds slightly favour a bull move
- A good stop level is if the strategy doubles in price (some also use a 50% increase, maybe use combination of both) i.e. you sell the strangle and receive 50 ticks and then buy it back on stop for around 100 ticks
- Always have a strict risk plan beforehand and STICK TO IT - Remember 1 or 2 very bad trades (stockmarket crash for example) can wipe out years of accumulated profits or even force you out of trading altogether. This has happened to countless option traders over the years, some of them very good but just too much risk one too many times.......
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