Option strategy sell Strangle/Straddle
In the chart, you see the strangle strategy when sold, I will show what will happen if the implied volatility changes, you can see this strategy being bought in the next post. You can come back to this post and watch how things play out.
As a rule of thumb, strategies are sold when implied volatility is relatively high and bought when implied volatility is relatively low, the seller would try to anticipate IV decrease and the buyer would try to anticipate IV increase.
Selling Strangle
The strangle is a position involving calls and puts, they will have the same expiration date but different strike prices. Selling Strangle is established by selling Out of the money calls and puts when the stock price is usually in the center.
This strategy when selling a strangle is neutral, the seller anticipates that in the life of the options the stock price will remain between the strikes, and at expiration, the options will be worthless and the seller will receive all the credit.
The green zone is the profit zone, the yellow lines are the break-even lines, the blue lines are losing lines, the lime green lines represent when you can realize 50% of the credit. I added pink broken lines to show where this strategy will have the maximum profit at expiration.
For example, from the chart, these options are from 29/10/2020 close in Zoom.
The strategy sold for -> 44.6, meaning credit is received.
Stock price-> 489.68 , Upper strike (call)-> 600, Lower strike (put)-> 400
Days-> 50, Impleid volatility-> 82% (0.82), date-> 29/10/2020
For one position we received 44.6, multiplying by 100 (number of shares per contract) if the stock price will be between 400 to 600 at the expiration date, all the options will expire worthless, the seller will receive all the credit $4460 this is the maximum profit.
Upper break-even point at expiration:
The upper strike + credit received = 600+44.6 = 644.6
Lower break-even point at expiration:
The lower strike - credit received = 400-44.6 = 355.4
Between 600-644.6 and 355.4-400, one of the options is not worthless at expiration, so it has intrinsic value, the seller will get between $0-$4460, the seller will need to close the position before expiration to avoid assignment.
If the price got to 689.2 or 310.8, the position is losing, in this case (-$4460), this strategy has a limited profit and theoretically unlimited loss.
You can see from the chart that It will take at least 22 days to realize 50% of the credit, some traders don’t want to wait until expiration and they prefer to close the position at 50% credit.
How implied volatility affects the position? (20% increase and decrease)
The blue area is the new profit zone, the purple lines are the new losing lines.
If the IV will raise after entering the trade (left chart), the seller will need to wait 18 days before his position will re-enter the profit zone, what was before a profit area will now be a losing area.
On the other hand, if the IV will fall (right chart), the seller will profit much quicker, the losing lines will be farther away.
Selling Straddle
This strategy is a private case to the strangle (the general strategy), in the straddle both options the calls and puts are at the same strike price, usually At the money.
The strategy is sold at the money because the time premium is the largest there.
This means that the seller receives a lot more credit for this strategy, the downside is for getting the maximum profit the stock price needs to finish exactly at the strike price, the probability for this to happen is less than 1%.
The opportunity to realize 50% of the maximum profit will take longer than the strangle, in this example 39 days. The break-even lines will be much closer.
The maximum profit for this example is $11,690, much larger than the strangle.
The risks are also much larger.
How implied volatility affects the position? (20% increase and decrease)
The selling of the strangle and straddle are not for beginner traders, due to the risk involved, a less risker strategy is the Iron Condor.
In the next post, I will show the buying side of the strategies.
As a rule of thumb, strategies are sold when implied volatility is relatively high and bought when implied volatility is relatively low, the seller would try to anticipate IV decrease and the buyer would try to anticipate IV increase.
Selling Strangle
The strangle is a position involving calls and puts, they will have the same expiration date but different strike prices. Selling Strangle is established by selling Out of the money calls and puts when the stock price is usually in the center.
This strategy when selling a strangle is neutral, the seller anticipates that in the life of the options the stock price will remain between the strikes, and at expiration, the options will be worthless and the seller will receive all the credit.
The green zone is the profit zone, the yellow lines are the break-even lines, the blue lines are losing lines, the lime green lines represent when you can realize 50% of the credit. I added pink broken lines to show where this strategy will have the maximum profit at expiration.
For example, from the chart, these options are from 29/10/2020 close in Zoom.
The strategy sold for -> 44.6, meaning credit is received.
Stock price-> 489.68 , Upper strike (call)-> 600, Lower strike (put)-> 400
Days-> 50, Impleid volatility-> 82% (0.82), date-> 29/10/2020
For one position we received 44.6, multiplying by 100 (number of shares per contract) if the stock price will be between 400 to 600 at the expiration date, all the options will expire worthless, the seller will receive all the credit $4460 this is the maximum profit.
Upper break-even point at expiration:
The upper strike + credit received = 600+44.6 = 644.6
Lower break-even point at expiration:
The lower strike - credit received = 400-44.6 = 355.4
Between 600-644.6 and 355.4-400, one of the options is not worthless at expiration, so it has intrinsic value, the seller will get between $0-$4460, the seller will need to close the position before expiration to avoid assignment.
If the price got to 689.2 or 310.8, the position is losing, in this case (-$4460), this strategy has a limited profit and theoretically unlimited loss.
You can see from the chart that It will take at least 22 days to realize 50% of the credit, some traders don’t want to wait until expiration and they prefer to close the position at 50% credit.
How implied volatility affects the position? (20% increase and decrease)
The blue area is the new profit zone, the purple lines are the new losing lines.
If the IV will raise after entering the trade (left chart), the seller will need to wait 18 days before his position will re-enter the profit zone, what was before a profit area will now be a losing area.
On the other hand, if the IV will fall (right chart), the seller will profit much quicker, the losing lines will be farther away.
Selling Straddle
This strategy is a private case to the strangle (the general strategy), in the straddle both options the calls and puts are at the same strike price, usually At the money.
The strategy is sold at the money because the time premium is the largest there.
This means that the seller receives a lot more credit for this strategy, the downside is for getting the maximum profit the stock price needs to finish exactly at the strike price, the probability for this to happen is less than 1%.
The opportunity to realize 50% of the maximum profit will take longer than the strangle, in this example 39 days. The break-even lines will be much closer.
The maximum profit for this example is $11,690, much larger than the strangle.
The risks are also much larger.
How implied volatility affects the position? (20% increase and decrease)
The selling of the strangle and straddle are not for beginner traders, due to the risk involved, a less risker strategy is the Iron Condor.
In the next post, I will show the buying side of the strategies.
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