Deploying short strangle by looking profit/loss at the payoff chart? – A must read for beginners!

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The market for selling options is currently seeing a large influx of newcomers. They have seen a lot of social media experts advising people that there is a good chance of making money if you deploy short strangles, but the truth is quite different. In this article, I will show you how a trade can be a big disaster if you are selling strangle by just looking at the profit/loss on the payoff chart.

Before we go further, let us understand what is a strangle strategy:

Deploying short strangle by looking profit/loss at the payoff chart? – A must read for beginners! Click To Tweet

What is a short strangle option strategy?

A strangle option strategy is a two-leg strategy where we are selling a OTM (Out of the money) Call option and a OTM put option. To understand this let’s take an example:

Nifty is trading at 15750 and we want to sell a strangle of 750 points away from the current price. So, the strategy will be:

  • Sell 16500 CE & 15000 PE

Below is the pay-off chart of a short strangle:

short strangle
image courtesy: opstra.definedge.com

Now you can see that, you will get profit from a short strangle if script expires between your breakeven.

.

But what about the loss when nifty breaches your breakeven?

Profit or loss in short strangle beyond breakeven

Now if you look at the payoff chart, your loss at your breakeven is around ₹12000. That means if nifty breached you breakeven due to any gap-up or gap-down you will lose around ₹12000.

This is the biggest mistake beginners are doing. Above payoff chart showing your profit/loss assuming that other Greeks will remain constant. Other Greeks means? Volatility.

Deploying short strangle by looking profit/loss at the payoff chart? – A must read for beginners! Click To Tweet

Option pricing heavily depends on volatility. Your option premium will be significantly impacted by a modest increase or decrease in volatility.

Here what beginner think. If Nifty start moving downward, I will get loss from PUT but will get profit from Call. So, my net loss will be low.

But What happens in reality?

If you get a breakout or breakdown due to any gap-up or gap-down, you IV (Implied Volatility) will increase. Right?

Now when you IV increase your premium will also increase. Right? That means you are getting loss in PUT due to delta (downside movement) and from IV.

On the other hand, what happens in your Call? Your premium will come down due to downside movement but because IV is increasing your premium will also increase. That nullify the decrease in premium due to delta.

In simple words, you will get high loss in PUT leg while barely making any money on the CALL leg and end up with a high loss without any idea about what is happening in your trade.

So, my friend, don’t fall in this trap of short strangle if you are a beginner and don’t know about option pricing, Greeks and implied volatility.

My advice for a beginner as an option seller

Remember that there is no such thing as “easy money” if you are a newbie.

Trading needs a foundational understanding and experience, just like any other industry. If you are serious about starting a career in options trading, you should look for a mentor with relevant experience, understand the fundamentals, and implement your plan gradually.

Don’t assume that putting a few lakhs to your trading account and reading articles on social media will make you a successful trader.

I hope this article will help you to choose your strategy wisely. If you have any query related to options strategies, can post in the comment box.



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DISCLAIMER: – we are not a SEBI research analyst. Views posted here only for educational purposes. There is no liability whatsoever for any loss arising from the use of this product or its contents. This product is not a recommendation to buy or sell, but rather a guideline to interpreting specified analysis methods.  This information should only be used by investors and traders who are aware of the risk inherent in securities trading.


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Sachin Sival is the founder and CEO of Replete Equities, an options trading company that specializes in delta hedging. A self-taught trader, Sachin has a passion for volatility trading and stock trading. Sachin loves to hone his skills by reading up on new strategies and techniques as well as taking part in industry events. In addition to being a successful entrepreneur, Sachin also takes pleasure in photography - as a hobby.

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