Sell Strangle Option Strategy
When volatility is very high, and the market has just
made a dramatic move and you are expecting it to
consolidate and take some time to digest its gains, you
might consider selling a strangle.
This strategy involves selling an out-of-the-money call
option and an out-of-the-money put option on the same asset
with the same expiration date. This strategy differs from
the Sell Straddle strategy because the options are not at
the same strike price. This provides a different
profit/loss curve that is worth checking out.
This gives you a known, but limited gain, but does expose
you to unlimited risk, so you must be careful with this
position and be confident of your assumptions. It is not
suitable for all investors.
With this strategy, your gain is composed of the
premium you received for the call and the put, less the
commissions.
When we sell a Strangle, the put and call that we
sell are normally on over-priced options that are out-the-
money. We consider doing this after a dramatic move in
the market, when we are expecting it to consolidate the
move and digest its gains before moving again. Because
of the dramatic move that was made, volatility is high,
making the options we sell very expensive. Then as the
market consolidates, volatility decreases and lowers the
price of the options. Decay also works in our favor with
this position.
But be ready to buy back one of the options if there is any
indication that the market will resume its trend or reverse
direction. If it looks like the market will trend up, buy
back the call; if it looks like the market will trend down,
buy back the put.
It is also important to cover risks and caveats of this
strategy.
The risk of this position is unlimited so you must be very
careful. Remember that the commission you pay for this
position will be higher because you are initiating two
related option transactions.
It is important to analyze your expectations for the
underlying asset and for the market before selecting your
strategy.
When you are analyzing potential option positions, it
helps to have a computer program like Option-Aid that
swiftly calculates volatility impacts, probabilities,
statistics, and other parameters of interest. These
programs can pay for themselves with the first trade that
they help you with.
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