Explanation

Short Strangle option strategy is similar to Short Straddle.The only difference is of the strike prices at which the positions are built.Executing of short strangleis made for net credit and involves selling call and put options. A trader will sell one out-of-the-money (OTM) call option and one out-of-the-money (OTM) put option, of same expiry date and of the same underlying asset. As the trader move toward OTM strikes, the premium received from entering into the contract become lesser and lesser. Trader’s capacity to face in the volatility increases as the further OTM options are sold.This option strategy will make profit if market volatility remains low and closesbetween the spread of the two strike prices. If by chance the market turn volatile, it will result in unlimited losses.Profit potential is limited to the total premiums received less commissions. Potential loss is unlimited if the stock price rises and substantial if the stock price falls.

Risk:

Unlimited

Reward:

Limited

Construction

Sell 1 OTM Call Option

Sell1OTM Put Option

Payoff Chart

Example

Suppose the Bank Nifty index is trading at 42800 levels and the trader is bearish on the volatility of the underlying. The trader expect index to trade in a range till expiry but at same time trader have some expectation of volatility. He implements short straddle option strategy. He sold OTM call at premium of Rs. 130 and OTM put at a premium of 145. His net investments will be Rs. 6875. [(130 + 145) *25]

Scenario 1:

At expiry if Bank Nifty stays in range of 42800 the trader will make profit, as both the call and put option will expire worthless. Max profit will be equal to the net premium received.

Scenario 2:

Opposite to the above scenario, if the index makes a volatile move to the upside or downside. The trader will lose in access to the breakeven point, which are mentioned above