Short-Strangle
| Range | Value |
|---|---|
Market expectation | Unchanged share prices |
Construction | Put short with strike price E1 |
Profit potential | Limited |
Risk of loss | Unlimited |
Time effect | Positive |
Volatility effect | Negative |
Market expectation
Similar to the short straddle, a short strangle is suitable if you expect the price of the underlying to stagnate with falling volatility. The difference is that the expectation of falling volatility is lower, i.e. a broader range is covered within which future prices may move.
Construction
The short strangle consists of a call short and a put short with the same remaining term but different strike prices. In the standard case, you choose the put short with a lower strike price, as in the example.
Profit potential
The profit potential of a short strangle is limited. The maximum profit is limited to the sum of the fair value components of the premiums received. It is achieved if the price of the underlying asset is quoted between the two strike prices on the expiry date.
Risk of loss
The risk of loss of a short strangle is unlimited. If the price rises above the upper break-even point, the put short expires, but the call short is subject to unlimited losses. If the price falls below the lower break-even point, the call expires and (virtually) unlimited losses are then threatened by the put short.
The lower break-even point is E1 minus premiums received, the upper break-even point is E2 plus premiums received.
Time effect
As a short position is taken in both positions, the fair value effect is positive.
Volatility effect
The volatility effect of the short strangle is clearly negative. The risks increase if volatility rises.