Option traders who believe the price of an underlying asset will not change significantly in the near future can sell short combinations of options that have different directional biases and strike prices. A short strangle is an option play designed to bet on a small move in either direction for an underlying stock in a set time frame. This is an option trading strategy that combines both short puts and short calls to create positions that profit from option premium time decay in a directionless market. Money is made by the lack of a defined price move in either direction. Short strangles make money if the stock price doesn’t move up or down significantly before the expiration of the options and creates profits from the loss of long option premium on both sides of the play. 

A short strangle is short call options at a higher strike price and short put options at a lower strike price at the same expiration and on the same stock. Such a position makes money if the stock price doesn’t moves up or down past the strike prices of the strangle. Both the short call and short put options are out-of-the-money strikes. A short strangle tries to sell the extrinsic value of two options and profit from neither side having more intrinsic value by expiration than the premium received from both options. There are higher costs and risks with these strategies than standard one sided option plays.

  1. Short strangles can be high risk plays during big price moves as one side of the options will go up in value when the other side goes down in value the majority of the time.
  2. If one side of the option play become worthless it generally means the other side is worth more.
  3. You can make money on short strangles when the market stays tightly range bound inside both option strike prices.
  4. It is less stressful to hold a short option position when there is a hedge in place if one of the options move against you, short strangle don’t include hedges so these plays can be risky during big market moves. 
  5. The big risks are transferred from the option buyer of the options to the short strangle seller of the calls and puts in this play.
  6. Short strangles lose with large price movements but win when there is little or no move. They are not asymmetrical bets in their construction and can lead to more risk than the option premium pays the seller for. The maximum loss is uncapped if one of the options go in-the-money. It is crucial to have a stop loss set based on a delta level that would make the option play no longer worth the risk. 
  7. If one side of the short options have an outsized move against you it will put you on the other side of the long option trader and your losses will be their gains.
  8. Short strangles can be played on any time frame.
  9. With the short strangles the losing side of the option play has a growing delta and the winning side has a shrinking delta.
  10. Short strangles can be used to bet against trends, volatility, and big reversals.

Where is the risk?

  • Time is on the side of the short strangle play, theta value is being lost as the long option traders wait for the move to take place.
  • You have bigger liquidity risk with options than with stocks, only play options with tight bid/ask spreads. It costs money to get in and out of these trades buying the ask and selling the bid. Focus on front month and close to the money options for maximum liquidity. 
  • Short strangle options can go down in premium value if implied volatility decreases and is priced out.
  • When a side of a short strangle goes in-the-money they transform into directional bets with high delta risk and you must exit to limit losses.
  • Commission costs are generally more expensive with options than stocks. Be aware of how much it costs with different numbers of contracts and how that will effect your P&L.

The short option strangle is a bet against a strong move or trend within a certain time frame and is a directionally neutral bet. 

short strangle
Gxti, CC BY 3.0 <https://creativecommons.org/licenses/by/3.0>, via Wikimedia Commons

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