Short Strangle Made SaferThe short strangle is one option technique that, by it self, does not pass as a safe-options-trading strategy. But it does have some attractive characteristics that make it interesting. Let’s examine it and how we can make it safer. The short strangle is constructed by a trader by selling two options: One short put at a strike price lower than the current price of the underlying and one short call at a strike price higher than the current underlying price. Example: XYZ is trading at $40. Sell 1 call at a 45 strike and one put at a 35 strike and you have your trade. As long as XYZ stays between the two strikes you will be safe. For each option, the further away the strike price is from the current underling price, the safer the trade will be. The attractive aspect of the this technique is that you collect two premiums simultaneously. So, what’s the downside? The big problem for safe option sellers is that one side of the trade is naked call. This is a big No-No, because you are exposed to near unlimited risk if the stock rises greatly to the upside. Let’s see … we’d still like to collect two premiums. How can we make this safer? Here’s how: Buy shares in the underlying ahead of time. Proceed to sell covered calls on the underlying. Then sell cash-secured puts as well. Sell both options far enough out-of-the-money that you’re not likely to be assigned, and you have created the safe short strangle. By now you've probably realized that the safe short strangle is essentially a covered call plus a cash secured put. The ideal scenario to use this modified technique is in a flat to gently rising market. It's best not to use highly volatile underlyings, because although the double premium is rich, the volatility swings can give you heartburn.
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