How to Sell Option Strangles for Double Premium in Commodities
The Strategy of Selling Strangles
Michael Gross Video Lesson
Hi, this is Michael Gross of OptionSellers.com here with your weekly Option Seller Email Seminar. The subject of this week’s seminar is The Strategy of Selling Strangles. We’re going to talk a little bit about why you might want to sell a strangle and some of the benefits to you for using such a strategy. One of the core concepts we discuss in The Complete Guide to Option Selling is pairing fundamentals of the commodity markets with selling deep out-of-the-money puts or calls. So, if you want to sell a call on the soybean market because you’re bearish, you’ll look to sell far above the market. If you’re bullish soybeans, you’ll look to sell a deep out-of-the-money put. There may be times where you either have balanced fundamentals or the market is trading in a defined range where you can employ a different strategy that’s called a strangle.
Let’s put it right up here. A strange is the strategy of selling both a put and a call at the same time. So, what that would look like is, I’m going to draw a price chart here, and this let’s say this is soybean prices over a 6-month period, okay? So, trading in a somewhat defined range. Say you’re bullish. Rather than just sell the put, you’re bearish, rather just sell the call, you can actually do both at the same time. You’re going to sell your put and you’re going to sell your call. You want to sell a deep out-of-the-money put and out-of-the-money call. What this does is if the market stays within this range and it’s in that range at expiration, what happens? Both of the options expire worthless. So, your call expires worthless and your put expires worthless. That means that everywhere between these two strikes is your profit zone. As long as the price of soybeans remains between these two strikes, and it’s there at expiration, both of your options expire worthless.
That’s how a strangle works. Now we want to talk about the benefits of a strangle or why you would want to do it. One of the primary benefits of the strangle is you get double premium, but you don’t have to pay double margin. If you sell a call, you’re going to put up a margin deposit to hold the call option. If you sell a put, you’re going to put up a margin deposit to sell the put option. If you sell them both at the same time, the margin requirement to hold that position will be less than it would be if you added the two individual margin requirements together. What that means to you is you get higher ROI, higher return on investment, if you’re successful in your strategy.
Another key benefit of the strangle, and this is one of our favorite reasons for using this strategy in a lot of different situations, you have an offsetting risk effect here. Let’s go back to our example…you’re in soybeans, you sold the put and the call. Two weeks later, the price starts going up, up, up, up, up towards your call strike. What’s happening to your call? The value of your call starts increasing in value. So, if you’re just naked the call you’re starting to watch that option and saying, “Where’s my exit point here?” If you’re at a strangle, you also have this put option on, so while the call option value is increasing your put option value starts decreasing. So, it’s offsetting at least partially some of the loss you’re taking on the call… at least on paper. A lot of investors like this, and we like it too, because it creates a little bit more stability in the position, it gives you a little bit longer staying power, and it gives the market a whole lot of room to move without having as big of an affect on your single position. So, that makes strangling one of our preferred strategies if the conditions are right and you probably want to consider it, too, depending on what market you’re trading.
As I mentioned, it’s a versatile strategy. The market can do a lot of different things and it can still be successful… another reason we like it. A strangle is best used in markets that are either non-trending. A lot of people think you can only sell a strangle in a market that’s moving sideways, and that’s not the case. Strangles can be effective in slow moving trending markets. So, whether the market is going like this, it doesn’t matter, it just has to stay in there. Even in slow markets heading down, as long as the thing isn’t going like this or like this, the strangle can be a pretty effective strategy in a lot of different market conditions. The last type of situation that a strangle works best in is in volatile markets. I have to quantify that a little bit because if a market is moving like this, you’re probably going to have to sell your strikes a little bit closer for your strangle, but if a market is going like this, well that really inflates values in both puts and calls. If you get a market that’s volatile but it’s still trading in somewhat of a range, then you might be able to sell calls here and puts down here. Those can be some of the best markets for selling strangles, so those are the type of markets that we look for.
Is there risk in a strangle? Of course there is. The market can still hit one of your strikes, it can still trade through one of your strikes. There may come a point where you do have to liquidate your put or your call if you’re wrong in the market and it breaks out one side or the other, but typically if you’re taking losses on one side you’re still getting some of it back for your profits on the other. So, it is another benefit of the strangle.
I hope you found this little piece we did here on strangles helpful to you. Of course, we talk about it a lot in The Complete Guide to Option Selling. If you have an interest in learning more about applying strangles and other types of strategies, we do have a report on our site I’d highly recommend. It’s called The Option Selling Solution. It’s free and you can get it on our website. Of course, if you have questions about working with us or accounts, I recommend getting our Option Seller Discovery Pack. It’s also free on the site. Thanks for coming to this week’s seminar and good luck on your trading.