Options Trading Strategies: Neutral - Short Strangle

Explanation

This strategy is similar to Short Straddle; the only difference is of the strike prices at which the positions are built. Short Strangle involves selling of one OTM Call Option and selling of one OTM Put Option, of the same expiry date and same underlying asset. Here the probability of making profits is more as there is a spread between the two strike prices, and if the markets do remain less volatile, then this strategy will start making profits for traders. The ideology behind this strategy is that the market will not be much volatile in the near future and the expected volatility will lie between the 2 strike prices. This strategy is used by expert traders who quantify the implied volatility accurately.

Risk: Unlimited

Reward: Limited

Construction

Sell 1 OTM Call Option
Sell 1 OTM Put Option

Example

Suppose NIFTY is trading around 5200 odd points, Mr. X does not expect the market to move much in the near future. As he is neutral about the volatility of NIFTY he will enter in a Short Strangle Strategy. He will sell 1 5300 OTM Call Option for a premium of Rs. 55 & sell 1 5100 OTM Put Option for a premium of Rs. 50. The lot size of NIFTY is 50. Hence, his account will get credited by Rs. 5000. [(50+50)*50]

Case 1: At expiry if NIFTY closes at 5000, then Mr. X will neither make profit nor loss. His net cash flow will be 0. [{(50)-(100-50)}*50]

Case 2: At expiry if NIFTY closes at 5250, then Mr. X will make a profit of Rs. 5000. [(50+50)*50]

Case 3: At expiry if NIFTY closes at 5400, then Mr. X will neither make profits nor losses. His net cash flow will be 0. [{(100-50)-(50)}*50]

Payoff Chart