The short strangle – one of our classic premium selling strategies. We combine an OTM short call above the price and an OTM short put below the price. Our best case scenario is that the underlying stays between our short strikes, and we collect the credit we have received for the trade. The tradeoff here is that our short options carry unlimited risk, so if the underlying moves significantly in one direction, then we will be on the hook for losses.
As part of our beginner series, we demonstrate how to set up a short strangle with both a fictitious example and a real example. As we have seen with other strategies, the strike selection for your short options is a balance between probability of profit and credit collected: the higher the POP, the lower the credit, and vice versa. In addition, it is important to remember that a short strangle is a play on time decay and volatility contraction. Therefore, this position is almost assured to show a negative P/L shortly after it has been originated because the underlying will likely have moved, but there hasn’t yet been an opportunity for time to pass or volatility to come in.
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