Option Strategies Details

A trader who wants to speculate on a decrease in volatility and a neutral price can sell a Short Strangle. The trader receives a credit, called a premium, to sell both the Put and the Call and has the obligation to buy 100 shares at the Call strike price as well as the obligation to sell 100 shares at the Put strike price.

Suppose stock XYZ is trading at $55. You forecast a decrease in volatility and a neutral XYZ price.

You sell a $51 / $58 Short Strangle (selling the $51 Put and selling the $58 Call) and receive a $1.78 credit to express this view. Your breakeven prices at expiry are $49.22, the short Put strike minus the credit received, and $59.78, the short Call strike plus the credit received. The max profit at expiry occurs if price is higher than $51 and lower than $58, but since the time component of your trade plan may not extend all the way to expiration you should be prepared to buy to close at a variety of XYZ prices as the market value of your $51 / $58 Short Strangle changes. Because the price of XYZ can, in theory, increase infinitely or decrease to $0, Short Strangles carry a high "risk of ruin". This means that an adverse price move, like a surprise earnings miss or buyout offer, can cause catastrophic losses. The fixed-risk "version" of a Short Strangle is a Short Iron Condor.