Stocks & Commodities V. 28:13 (38-43): Diary Of A Strangle by Charles Steiner
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Diary Of A Strangle by Charles Steiner
Here’s how you can apply this low-risk option strategy.
Option strategies can be created to accomplish almost any speculative objective. One low-risk option strategy is the short strangle. Simply stated, a strangle is a combination of an out-of-the-money put and an out-of-the-money call with the same expiration date. The obvious advantage of this combination is that there is an expectation of a 50% or greater probability of success because only one of the two options could be in-the-money at expiration. Therefore, in setting up a strangle you must determine where the option probably will not go rather than where it might go.
There must be an exit or hedging plan in the event that one side of the strangle ends up in-the-money. Another advantage of the short strangle is that it is margin-efficient. Being out-of-the-money, the margin requirement is reduced and only the side closest to being in-the-money is used to compute margin. An additional advantage is that this strategy lends itself to delta-neutral trading by allowing dynamic hedging, which is the addition or subtraction of short or long positions in the underlying security or additional option positions.
Delta-neutral refers to the strategy of balancing the positive deltas of the short calls against the negative deltas of the short puts to reduce the risk of the position in order to allow the time decay of the premiums collected to work its magic. Delta is the relationship between the change in the price of the underlying asset to the change in price of the corresponding option. The delta of a short 100 call would be +0.50 when the underlying was valued at 100. Thus, the option price would decrease about 0.50 if the underlying fell to 99, all other factors remaining the same. At 101 the call option would be expected to increase 0.50 under the same circumstances. The delta of an at-the-money short put would be ‑0.50 and the option would increase in value as the price of the underlying dropped and the put option would decrease in value when the price of the underlying increased.
The delta of a long asset position would be ‑1.00 and the delta of a short asset position would be +1.00. A mini futures contract or fewer than 100 shares of a stock would have a delta, a fraction of a full-sized contract. In addition, delta is an approximation of the probability of an option closing in-the-money.
Here’s how you can apply this low-risk option strategy.
Option strategies can be created to accomplish almost any speculative objective. One low-risk option strategy is the short strangle. Simply stated, a strangle is a combination of an out-of-the-money put and an out-of-the-money call with the same expiration date. The obvious advantage of this combination is that there is an expectation of a 50% or greater probability of success because only one of the two options could be in-the-money at expiration. Therefore, in setting up a strangle you must determine where the option probably will not go rather than where it might go.
There must be an exit or hedging plan in the event that one side of the strangle ends up in-the-money. Another advantage of the short strangle is that it is margin-efficient. Being out-of-the-money, the margin requirement is reduced and only the side closest to being in-the-money is used to compute margin. An additional advantage is that this strategy lends itself to delta-neutral trading by allowing dynamic hedging, which is the addition or subtraction of short or long positions in the underlying security or additional option positions.
Delta-neutral refers to the strategy of balancing the positive deltas of the short calls against the negative deltas of the short puts to reduce the risk of the position in order to allow the time decay of the premiums collected to work its magic. Delta is the relationship between the change in the price of the underlying asset to the change in price of the corresponding option. The delta of a short 100 call would be +0.50 when the underlying was valued at 100. Thus, the option price would decrease about 0.50 if the underlying fell to 99, all other factors remaining the same. At 101 the call option would be expected to increase 0.50 under the same circumstances. The delta of an at-the-money short put would be ‑0.50 and the option would increase in value as the price of the underlying dropped and the put option would decrease in value when the price of the underlying increased.
The delta of a long asset position would be ‑1.00 and the delta of a short asset position would be +1.00. A mini futures contract or fewer than 100 shares of a stock would have a delta, a fraction of a full-sized contract. In addition, delta is an approximation of the probability of an option closing in-the-money.
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