A short strangle gives the obligation to buy the stock at strike price A and the obligation to sell the stock at strike price B if the options are assigned. You are predicting the stock price will remain somewhere between strike A and strike B, and the options you sell will expire worthless.
By selling two options, significantly increase the income you would have achieved from selling a put or a call alone. But that comes at a cost. There is unlimited risk on the upside and substantial down. This strategy is only for the most advanced traders who like to live dangerously .
There are two break-even points:
· Strike A minus the net credit received.
· Strike B plus the net credit received.
PROFITS AND LOSSES IN THE STRATEGY:....
1. If the stock at or between strikes A and B at expiration, so the options expire worthless.
2. Potential profit is limited to the net credit received.
3. If the stock goes up, the losses could be theoretically unlimited.
4. For this strategy, time decay is the best friend. It works doubly in your favor, eroding the price of both options you sold. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.
5. After the strategy is established, you really want implied volatility to decrease. An increase in implied volatility is dangerous because it works doubly against you by increasing the price of both options you sold.