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A short strangle is an options strategy similar to a short straddle, but with different strike prices for the call and put options. It involves selling an out-of-the-money (OTM) call option and an out-of-the-money put option on the same underlying asset with the same expiration date. The call strike price is higher than the current market price, and the put strike price is lower.
Limited Profit Potential: Profits are capped by the premium collected from selling the options minus any commissions.
Limited Risk, but not Unlimited: While not unlimited like a short straddle, losses are still significant if the price moves outside the wider range defined by the strike prices.
Neutral to Slightly Bearish Outlook: This strategy assumes the asset price will remain within a defined range or move modestly in either direction.
Lower Volatility Benefit: Compared to a short straddle, it benefits from lower volatility as the wider range provides some buffer against price movements.
Selling the OTM Call Option: You grant the buyer the right (but not the obligation) to buy the asset at the higher strike price by the expiration date. If the price rises significantly above the strike price, you will be obligated to sell the asset at a lower price, potentially incurring a loss.
Selling the OTM Put Option: You grant the buyer the right (but not the obligation) to sell the asset to you at the lower strike price by the expiration date. If the price falls significantly below the strike price, you will be obligated to buy the asset at a higher price, potentially incurring a loss.
The asset price stays within the range defined by the strike prices until expiration. You keep the premium collected without being assigned either option.
The asset price moves slightly in either direction, but not enough to trigger assignment of either option. You still keep the premium.
The asset price rises significantly above the call strike price, and the call option is exercised. You are forced to sell the asset at the lower strike price, leading to a significant loss.
The asset price falls significantly below the put strike price, and the put option is exercised. You are forced to buy the asset at the higher strike price, leading to a significant loss.
Similar to the short straddle, this strategy is generally considered advanced due to its unfavorable risk-reward profile. However, the wider strike range compared to a straddle offers some moderation in potential losses. It's still suitable only for experienced options traders who understand the risks involved and have a high tolerance for potential losses.
Remember, while the potential losses are not unlimited, they can still be significant if the price moves outside the defined range. Choose this strategy carefully and understand the risks involved before putting your capital at stake.
The break-even point for an option strategy is the underlying asset price at the expiration date where the strategy neither makes a profit nor suffers a loss. It takes into account the combined costs and potential payoffs of all options involved in the strategy.
In options trading, the probability of profit (POP) reflects the likelihood of your chosen strategy resulting in a profitable outcome by the expiration date. While it's not a foolproof indicator, it can be a helpful tool for assessing potential risk and reward scenarios.