This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

Duration: 1:39

Instructor:

Contributor: Interactive Brokers

Level: Intermediate

When neutral on the outlook for a stock, an investor might wish to generate income by selling different strike call and put options hoping that the stock will remain stuck in a defined range. Because implied volatility is a significant determinant of an option’s premium, investors also try to take advantage of diminishing volatility ahead to sell strangles.

## Study Notes:

Short Strangle example –

• Underlying XYZ stock price: \$80.00
• Call strike price:85.00
• Put strike price:75.00
• Days to expiration:90
• Profit potential: Limited to the combined premiums from both call and put or \$5.50 and occurs at all points between the \$75.00 and \$85.00 strike prices. Until the upper strike price neither the call nor put has zero intrinsic value. And so, between the strikes, the investor retains both premiums. Below the strike price of the put the value of the combined premium is eaten away, as the intrinsic value of the put option increases. Conversely, above the strike price of the call, that combined premium begins to diminish as the intrinsic value of the call increases.
• Potential profit: @\$80.00 – Both put and call options are out-the-money and each has zero value. The investor gets to keep the entire \$5.50 premium collected from the sale of each option.
• @\$60.00 – The out-the-money call option now has zero intrinsic value. However, the put option is now in-the-money by \$15.00 (\$75.00 minus \$60.00) and this must be subtracted from the combined \$5.50 premium, which leaves the investor at a total loss of \$9.50 (\$15.00 – \$5.50 = \$9.50).
• Maximum loss: Just like with a short straddle strategy, the short strangle seller faces potentially unlimited losses to the upside, since the intrinsic call value keeps up with the rising share price penny-for-penny. Losses to the downside can be significant as the intrinsic nature of the put option matches the downside performance of the stock penny-for-penny, limited only by a zero value for the underlying share price.

Market Outlook – Neutral

Dividends – Neutral

Interest Rate – Neutral

Profit Potential – Limited

Loss Potential – Substantial from short put/ unlimited from short call

Components – Sell lower strike put and higher strike call option with same expiration

 Underlying Stock \$   80.00 Underlying Stock Call P&L Put P&L Total P&L Call Strike \$   85.00 \$                 10.00 \$               300 \$        (6,250) \$      (5,950) Premium \$     3.00 \$                 15.00 \$               300 \$        (5,750) \$      (5,450) Put Strikes \$   75.00 \$                 20.00 \$               300 \$        (5,250) \$      (4,950) Premium \$     2.50 \$                 25.00 \$               300 \$        (4,750) \$      (4,450) Net Premium \$     5.50 \$                 30.00 \$               300 \$        (4,250) \$      (3,950) \$                 35.00 \$               300 \$        (3,750) \$      (3,450) \$                 40.00 \$               300 \$        (3,250) \$      (2,950) \$                 45.00 \$               300 \$        (2,750) \$      (2,450) \$                 50.00 \$               300 \$        (2,250) \$      (1,950) \$                 55.00 \$               300 \$        (1,750) \$      (1,450) \$                 60.00 \$               300 \$        (1,250) \$         (950) \$                 65.00 \$               300 \$           (750) \$         (450) \$                 70.00 \$               300 \$           (250) \$             50 \$                 75.00 \$               300 \$             250 \$           550 \$                 80.00 \$               300 \$             250 \$           550 \$                 85.00 \$               300 \$             250 \$           550 \$                 90.00 \$              (200) \$             250 \$             50 \$                 95.00 \$              (700) \$             250 \$         (450) \$               100.00 \$          (1,200) \$             250 \$         (950) \$               105.00 \$          (1,700) \$             250 \$      (1,450) \$               110.00 \$          (2,200) \$             250 \$      (1,950) \$               115.00 \$          (2,700) \$             250 \$      (2,450) \$               120.00 \$          (3,200) \$             250 \$      (2,950)
##### Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Supporting documentation for any claims and statistical information will be provided upon request.

Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.