Selling my First Strangle

by Evan

In effort to learn different income producing options strategy I have been reviewing various strategies and deciding whether they are appropriate for me to actually trade.  Lat week I reviewed the very popular Strangle Option Strategy and prematurely stated, it isn’t something that I would be interested in selling any time soon.  It took another blogger, JC from Passive Income Pursuit, to force me to look at the strategy from a different angle.  His single comment gave rise to me selling strangles!

How Does Selling a Strangle Option Work?

While my post defining a strangle option went into much more detail, a Strangle, is actually a pretty easy strategy to understand if you have a basic knowledge of options.  When a person writes a strangle they are:

  • Selling an out of the money put
  • Selling an out of the money call

So let’s break down the two sides of the position:

  • The seller is collecting a premium taking the position that that the stock won’t go below a price certain (in the above example that number is $35/share); and
  • The seller is collecting a premium taking the position that the stock won’t go above a price certain (in the above example that number is $45/share).

So, as long as the stock stays within the range above ($35 – $45) the strangle seller receiving two premiums.

Why Was I Against Selling Strangles At First?

As soon as I started researching the strangle, I thought to myself that the strategy was not for me for one reason that I explicitly shared,

I am not sure why a retail investor would sell a short strangle.  The risk seems absolutely ludicrous.  I am sure there is an application for professionals, but the idea of guessing whether a company is going to stay lower than a particular strike price (selling to open a call) seems like a very, very risky proposition.

Put a different way, I do not understand selling uncovered calls.  If a stock goes above the strike price, I am just basically paying out of pocket the difference between the actual stock price and the strike price.  I look at this differently than being assigned a put since if I were to “lose” that position at least I am holding 100 shares of a company.

How was I convinced to Write Strangles?

A few hours after that post went live JC wrote,

…I’m a bit surprised that a short strangle doesn’t sound like something you’d be willing to do. Unless you’re using options solely to exit positions/increase income via covered calls or cash secured puts in order to enter positions, I don’t see why a short strangle is all that different from just selling a call or put…I’ve also been doing covered strangles in order to generate more option income/premium or reduce my cost basis on positions where I own 100 shares. So far it’s worked out pretty well.

It may seem elementary for experienced traders, but JC provided me with a paradigm shift.  I was looking at the strategy with a bias against selling uncovered calls, but he was completely correct – I was holding a few positions wherein I was assigned shares at a paper loss, so why not take a bet on both sides of those companies?

From what I figure there are three mutually exclusive outcomes:

  • The stock stays within the predefined range and I keep both premiums
  • The stock drops and I am assigned new shares reducing my cost basis (remember I already own shares)
  • The stock pops and I keep the premium and I get out from under the position

Highlighting my First Few Strangle Sales

The First trade I did was to pair up a covered call I already had on the books.  At some point in the past (timing doesn’t really matter for this post) I was assigned AOBC (Smith and Wesson) shares at a cost basis of $23.  Since that assignment I was selling covered calls little by little to make up the difference between the current price and the assignment price.  Well, with JC’s comment it made me realize, if I am long on the company why not pair it up with selling a put.  Again, if the stock is put to me all it does is reduce my cost basis since I do not have any plans of unloading the stock anytime soon.

The second trade I did was a true (covered) strangle.  Currently, I am holding a few hundred shares of URBN, but only did one trade (100 shares) wherein I sold two separate contracts:

  • May 12 $20 Put for $.18
  • May 12 $26 Call for $.12

The reason I only did 100 shares was that my basis in the 400 shares is in the 30s, so I didn’t want the whole thing sold from underneath me in case there is a huge jump.  Instead, my plan is to keep selling 1 or 2 contracts at a time, waiting for the company to recover.

You may also like


JC April 23, 2017 - 6:03 am

I completely agree with you about not wanting to sell uncovered calls. While I think there’s a time and place for it for more experience options sellers it’s not quite something that I want to go into yet. I’m glad you were able to see the benefit of selling covered strangles around long stock positions. I’ve been doing so with some of my positions when shares were put to me and I’ve been able to reduce my cost basis much more than just selling a covered call against it. It’s worked out pretty well and I like the strategy.

I’ve been toying with some other ideas to generate a higher premium compared to just selling a covered call and while the covered strangle is good the problem is that you might have to own an additional 100 shares of the company. For portfolio diversification as well as capital constraints that might not be the best thing. Some other things you can look into are call ratio spreads or the “reverse big lizard” (a short straddle with a long OTM put). Both of those have similar P/L graphs as the covered call but have other benefits that can juice up the premium you can receive if the share price lands at certain points while also allowing you to move your breakeven point, strike price + premium in the case of the covered call, out further.

The call ratio is buying one call option and selling 2 call options at a higher strike which should be done for a net credit. The plus is that you move your “sale price” further out compared to the CC and if the share price lands near your short calls then you collect more credit than you would have by selling just a covered call. But if the share price is below your lower long call then you have a smaller option premium than just selling the covered call. So the tradeoff is higher potential sale price with the potential for higher option income if you close the position versus potentially lower net credit in the case that everything is OTM. But you have no additional risk to the downside in the form of having to buy another 100 shares.

The reverse big lizard is effectively the same tradeoff. Although what I’ve been looking at is instead of selling an ATM straddle I’ve been looking at selling the straddle at the covered call that I’d want to sell and then buying a put 1 strike below the straddle. This has the same pros and cons as the call ratio spread.

Both of those are more complex but I’m looking at putting those on with some of the positions that I was assigned on this past Friday. Of course doing these in an IRA is proving to be a pain because my broker won’t let you do it in one trade so you have to do it in 2 which means more commissions. Although I’m hoping to chat with them this week to see if there’s a way around it.

All the best and I’m glad you’re able to start chipping away at your cost basis a bit faster than just using CC’s. Let me know what you think about the call ratio or reverse big lizard.

Amber tree April 23, 2017 - 9:30 am

Uncovered calls are not yet for me. I do covered calls, and have positive results so far.

A covered strangle is ok for me. I do it often, for the same reasons as you

When I get more mature and more relax with options and the risk, I will not mind naked strangles. When the stock goes up, the put goes down and you can use that money to close the call. Look at Tastytrade, they do it very often with great results.


Leave a Comment