?> Chris Butler, Author at projectfinance - Page 5 of 10

## Selling Call and Put Options: The Complete Guide

Before you learn of shorting call and put options, you must first understand the basic components of these strategies. Let’s get started with learning about intrinsic and extrinsic value!

## Intrinsic & Extrinsic Value

There are two components that make up the whole of an option’s price, known as Intrinsic & Extrinsic value. Let’s go through each of them one by one:

## Intrinsic Value

If you’ve gone through the first part of this guide, you don’t know it yet, but you already understand what an intrinsic value represents in an option’s price.

We had a house example in the first part where the house was valued at \$350,000, and we had a call option to buy it at a strike price of \$200,000. In that example, since we could buy the house \$150,000 less than its current value (a benefit of \$150,000), the call is said to have an intrinsic value of \$150,000.

It means that the option contract in the home example is worth at least \$150,000 because we, as the owner, can use it for a benefit or profit of \$150,000.

For put options, it’s the opposite. If you have a put option with a strike price of \$130 while the stock price is at \$120, you have a put contract that can sell stock \$10 higher than its current value, meaning a profit of \$10. This \$10 is called the intrinsic value of the option.

To sum up, intrinsic value is the real value that an option can provide to its owner, and it is the minimum value of an option contract.

## Extrinsic Value

The second component is called Extrinsic Value. An option’s extrinsic value is the portion of the option’s price that exceeds its intrinsic value. Let’s take an example to better understand it:

In the image above, TSLA is trading at a share price of \$836.41 and we can see a call option with a strike price of \$800. So as you can guess, the call option has an intrinsic value of \$36.41, which is the benefit or real value it can provide to its owner.  Why? Because the 800 call can be used to buy shares at \$800/share, which is \$36.41 below the current share price of \$836.41.

But as we can see, the actual option price is \$94.10, which is much higher than its intrinsic value. Here, the portion of the TSLA option’s price that is above its intrinsic value of \$36.41 is called its extrinsic value.

We can understand an option’s extrinsic value as the part of its price associated with the potential for the option to become more valuable before its expiration. That is why the extrinsic value is sometimes referred to as “time value.”

As time passes, extrinsic value is lost, leaving only intrinsic value at expiration.

So in the case of this TSLA option, it has a 30-day expiration period. And going by TSLA’s volatility, we all know it can move around a lot in a 30-day period. So if TSLA ends up climbing to \$900 by the option’s expiration date, its intrinsic value will increase to \$100, which is why it makes sense that its current extrinsic value is \$57.69.

This brings us to another point: options with a longer-term expiration date will trade with higher levels of extrinsic value compared to those with shorter expiration dates, because of the simple reason that with more time until expiry, stocks have larger potential movements.

## In-the-Money (ITM), Out-of-the-Money (OTM), At-the-Money (ATM)

These are the three terms that you’ll get to hear often as an options trader, that’s why it’s important to cover them before we get to shorting options.

These terms essentially describe whether or not an option has intrinsic value or not. They represent the “moneyness” of an option.

In-the-money means any option with intrinsic value. So in our TSLA example, if the call’s strike price is \$800 while the stock price is \$836, the call has an intrinsic value of \$36. Therefore, the call is said to be “in-the-money.”

Out-of-the-money is the exact opposite. Any option is said to be out-of-the-money when it has a 100% extrinsic value or no intrinsic value.

An example could be the IWM put option with a put strike price of \$130 and a stock price of \$130.71. The put option doesn’t have any intrinsic value in its price and therefore it is said to be an out-of-the-money put option.

The last term is at-the-money, which is when an option has a strike price equal to or very close to the current stock price.

## Shorting Options

Shorting options can be confusing for beginners because here you’ll learn that we don’t always buy options, we can actually bet against them too. Betting against an option means that we put on a trade that profits when the option price falls.

If you know stock trading, then you probably know what shorting stocks is. It means that you sell the stock first at the current price without owning the shares, and then close your position by buying them back in the future, ideally at a lower price.

Shorting options is the same concept, but instead of stocks, you short options. You open your position by selling options you don’t own and your goal is to buy back the option at a lower price in the future.

So for example, say I short a call option for \$5, meaning I collect a premium of \$500 in my account, and later if the option price falls to \$3, I buy back the option at a premium of \$300, making a \$200 profit on the trade.

## Shorting Call Options With an Example

Let’s take a real-life example of shorting a call option to get a complete understanding of the subject:

In the above image, we can see that the current share price of IWM is \$120.59, and we look at shorting the June 125 call option (strike price of \$125). The call option is 100% extrinsic value, meaning it is “out-of-the-money.” The option’s price is \$4.66, which, again, is 100% extrinsic.

Now since we’re shorting options, I’ll not pay the \$466 premium, rather I’ll collect it in my account, as we’re selling this option right now. But remember, collecting the money doesn’t mean it produces a profit. I’ll still have to buy it at a lower price to realize any profit.

Before we move forward, I must tell you that this is an extremely risky trade to enter. Because a call option’s price increases with the stock price, and since there’s no upper limit to how high a stock’s price can go, a call option also has no upper price limit. Therefore, “shorting a naked call option” like this trade has unlimited loss potential, in theory.

And since it is such a risky strategy, you’ll have to have a margin account. That means you have to be able to put collateral aside to enter the position. So the example that we’ve just seen above would require me to have \$2,000 set aside in my account to bear potential losses if I want to short this call option.

## Short Call Breakeven Price

Before we move forward, it is important to discuss the concept of the breakeven price and how it is possible to make money even if the stock price is above the call’s strike price. Say you short a call option in NFLX (Netflix) with a strike price of \$400 and short it for \$17 (you collect \$1,700).

The breakeven price for this call trade is \$417. But why? Because at expiration, an option will only have intrinsic value, if any. For a call option with a strike price of \$400, the call will have \$17 of intrinsic value if the stock price is at \$417. If the stock price is at \$417 at expiration, the call will be worth \$17 (premium of \$1,700). Since that’s the same as my initial sale price, I’d have no profit or loss if the option was worth \$17 at expiration.

And so if NFLX is below \$417 at expiration, the call will be worth less than the initial sale price of \$17, and the short call position will profit.

That is how it is possible to make a profit on a short call even if the stock price is higher than the call’s strike price at the expiration date.

## Shorting Put Options

Thus far, we’ve talked about buying call options, buying put options, and shorting call options. Finally, we’ll be talking about shorting put options.

Similar to shorting call options, you sell the put option first and then buy it later at a lower premium (hopefully). As we know, put option prices decrease when the stock price increases, which means betting against a put option would mean betting in a stock price increase.

This is why shorting put options is a bullish trade: you profit when the stock rises and face losses when it falls.

### Example

For this example, we’ll look at a put option in Activision (ATVI). On the left-hand side of the chart below, ATVI is trading at \$67 per share. So let’s say I’m a trader who wants to profit from the increase in ATVI but at the same time, I’m not super sure that the stock price will increase.

In this case, shorting put option will be one available options trade for me. And so I decide to short the May 65 put option at a premium of \$175, which I collect when entering the trade. I need to buy back the put for less than \$175 to make a profit.

In the left-hand chart, we can see that the stock price increased significantly by the expiration date of the put, and the put option price (right-hand chart) sank to just \$0.02. This means that the option that I sold earlier at a premium of \$175, I can now buy it at a premium of \$2, making a profit of \$173.

So that wraps it up for this part. Up until now, we’ve talked about four basic option trades: buying calls, buying puts, shorting calls and shorting puts. These four trades will make up any options trading strategy that you’ll ever see in the future. We also discussed how option prices work and the price components, and also went over terms such as In-the-money, out-of-the-money, and at-the-money.

## Long Iron ﻿﻿﻿Butterfly Explained – The Ultimate Guide

The long iron butterfly options strategy consists of simultaneously buying a call option and a put option at the same strike price (a long straddle), and selling an out-of-the-money call and out-of-the-money put (a short strangle).

All options must be in the same expiration cycle.

A long iron butterfly position can be conceptualized in two ways:

1) Simultaneously buying a straddle and selling a strangle (as described above).

2) Simultaneously buying a call spread and put spread with the purchased options having the same strike price.

TAKEAWAYS

• The “long butterfly” is simply the combination of a long straddle and a short strangle.

• This position is directional; the trader is hoping for either large upside or downside moves.

• The strategy profits when the underyling breaches the “wings” by expiration.

• Max loss is the net debit paid; max profit is (Strike Width of Widest Spread – Debit Paid).

## Long Iron Butterfly Strategy Characteristics

The long iron fly strategy is very similar to a long straddle, except a long iron fly has less risk because the options that are sold reduce the entry cost of the position.

Let’s go over the strategy’s general characteristics:

➥Max Profit Potential: (Strike Width of Widest Spread – Debit Paid) x 100

➥Max Loss Potential: Debit Paid x 100

➥Expiration Breakeven:

Upper Breakeven = Long Strike + Debit Paid

Lower Breakeven = Long Strike – Debit Paid

➥Estimated Probability of Profit: Less than 50% because the stock price must move significantly in either direction and/or implied volatility must increase for profits to occur.

To explain these characteristics in more detail, let’s look at a basic example:

## Long Iron Butterfly P/L Potential at Expiration

In the following example, we’ll construct a long iron butterfly from the following option chain:

In this case, we’ll buy the 300 call and 300 put for a total debit of \$24.25, and we’ll sell the 250 put and 350 call for a total credit of \$1.31. Let’s also assume the stock price is trading for \$300 when we put this trade on:

Initial Stock Price: \$300

Short Strikes: \$250 short put, \$350 short call

Long Strikes: \$300 long put, \$300 long call

Credit Received for Short Options: \$1.31​

Debit Paid for Long Options: \$24.25

Total Debit Paid: \$24.25 Debit – \$1.31 Credit = \$22.94

The following visual describes the position’s potential profits and losses at expiration:

### Long Iron Butterfly at Expiration

As we can see here, a long butterfly’s profit potential lies well outside of the long strike price. In this example, the stock price must move ±\$22.94 just for the position to break even and ±\$50 to reach maximum profit at expiration.

As a result, the position has a low probability of profit, which is also supported by the fact that the profit potential is greater than the loss potential.

The table below explains the performance of this position based on various scenarios at expiration:

Stock Price Below the Short Put Strike (\$250) -OR- Above the Short Call Strike (\$350):

One of the spreads of the long iron butterfly expires fully in-the-money. With spreads strikes that are \$50 wide, the iron fly would be worth \$50. Due to an initial purchase price of \$22.94, the long iron butterfly trader realizes the maximum profit of \$2,706: (\$50 iron fly expiration value – \$22.94 purchase price) x 100 = +\$2,706.

Stock Price Between the Short Put Strike (\$250) and the Lower Breakeven Price (\$277.06):

The long 300 put is worth more than the \$22.94 the iron fly was purchased for, and therefore the iron fly position is profitable at expiration. All other options expire worthless.

Stock Price Between the Lower Breakeven Price (\$277.06) and the Long Put Strike (\$300):

The long 300 put has intrinsic value, but not more than the \$22.94 that was paid for the iron butterfly. Because of this, the position is not profitable (or breaks even if the stock price is exactly \$277.06). All other options expire worthless.

Stock Price At the Long Strike (\$300):

All of the iron butterfly’s options expire worthless, resulting in the maximum loss of \$2,294. This scenario is extremely unlikely because it only occurs at one specific price.

Stock Price Between the Long Call Strike (\$300) and the Upper Breakeven Price (\$322.94):

The long 300 call has intrinsic value, but not more than the \$22.94 the iron fly was purchased for. Because of this, the position is not profitable (or breaks even if the stock price is exactly \$322.94). All other options expire worthless.

Stock Price Between the Upper Breakeven Price (\$322.94) and the Short Call Strike (\$350):

The long 300 call has more intrinsic value than the \$22.94 paid for the iron fly. Because of this, the position is profitable.

So, you know how the outcomes at expiration when buying iron flies, but what about before expiration? Understanding how profits and losses occur can be explained by the position’s option Greeks (if you want to improve your understanding of the risks your option positions carry, read our ultimate guides on the option Greeks).

You’ve learned the general characteristics of the long iron fly strategy. Next, we’re going to visualize the performance of the strategy over time by looking at some trade examples.

## Long Iron Butterfly Trade Examples

In this section, we’re going to visualize the performance of some long iron fly positions that recently traded. Note that we don’t specify the underlying, since the same concepts apply to long iron flies on any stock.

Additionally, each example demonstrates the performance of a single iron fly position. When trading more contracts, the profits and losses in each case will be magnified by the number of iron flies traded.

Let’s do it!

## Trade Example #1: Breaking Even

The first example we’ll look at is a scenario where a trader buys an iron fly, but the stock price is near one of the breakeven prices at expiration.

Initial Stock Price: \$105.79

Strikes and Expiration: Long 106 Call and Put; Short 97 Put and 112 Call; All options expiring in 45 days

Premium Paid for Long Options: \$3.04 for the 106 put + \$2.50 for the 106 call = \$5.54 in premium paid

Premium Collected From Short Options: \$0.77 for the 97 put + \$0.35 for the 112 call = \$1.12 in premium collected

Net Debit: \$5.54 in premium paid – \$1.12 in premium collected = \$4.42 net debit

Breakeven Prices: \$101.58 and \$110.42 (\$106 – \$4.42 and \$106 + \$4.42)

Maximum Profit Potential (Upside): (\$6-wide call spread – \$4.42 debit) x 100 = \$158

Maximum Profit Potential (Downside): (\$9-wide put spread – \$4.42 debit) x 100 = \$458

Maximum Loss Potential: \$4.42 debit x 100 = \$442

As mentioned earlier, the maximum profit potential of a long iron butterfly depends on the wider spread. In this example, the long call spread is \$6 wide, and the long put spread is \$9 wide. Because of this, the maximum profit potential of this iron fly occurs when the stock price collapses through the long put spread. More specifically, this trade has \$158 in profit potential on the upside and \$458 in potential profits on the downside, resulting in a bearish bias.

Let’s see what happens!

### Iron Fly #1 Trade Results

As you can see, the long iron fly position does not perform well because the stock price does not rise fast enough over the period. At expiration, the stock price is just above the upper breakeven price of the position, resulting in minimal profits.

At expiration, the trader would end up with +100 shares of stock because the long 106 call is in-the-money. If the trader wanted to avoid a stock position, they would have to sell the 106 call before expiration.

## Trade Example #2: Max Profit Iron Fly

In the following example, we’ll investigate a situation where the stock price rises continuosly and is above the long call strike price at expiration.

Here are the specifics:

Initial Stock Price: \$74.44

Strikes and Expiration: Long 75 Put and Call; Short 70 Put and 80 Call; All options expiring in 39 days

Premium Paid for Long Options: \$2.80 for the 75 put + \$2.29 for the 75 call = \$5.09 in premium paid

Premium Collected for Short Options: \$0.95 for the 70 put + \$0.67 for the 80 call = \$1.62 in premium collected

Net Debit: \$5.09 in premium paid – \$1.62 in premium collected = \$3.47 net debit

Breakeven Prices: \$71.53 and \$78.47 (\$75 – \$3.47 and \$75 + \$3.47)

Maximum Profit Potential: (\$5-wide spreads – \$3.47 net debit) x 100 = \$153

Maximum Loss Potential: \$3.47 net debit x 100 = \$347

In this example, both the long call spread and long put spread are \$5 wide, so the profit potential is equal on both sides of the trade. Let’s take a look at what happens!

### Iron Fly #2 Trade Results

In this example, the long iron fly performs well because the stock price rises through the long call spread in a timely manner. At expiration, the long 75/80 call spread is entirely in-the-money, resulting in an expiration value of \$5. The long put spread expires worthless, but it doesn’t matter. With an initial purchase price of \$3.47, the \$5 value of the iron fly’s call spread at expiration results in the maximum profit of \$153: (\$5 iron fly expiration value – \$3.47 purchase price) x 100 = +\$153.

## Trade Example #3: Significant Loss

In the final example, we’ll examine the worst-case scenario for a long iron fly, which is when the stock price expires near the long strike. Here’s the setup:

Initial Stock Price: \$752

Strikes and Expiration: Long 750 put and call; Short 625 Put and 875 Call; All options expiring in 46 days

Premium Paid for Long Options: \$36.25 for the 750 put + \$37.30 for the 750 call = \$73.55 in premium paid

Premium Collected for Short Options: \$4.50 for the 625 put + \$2.90 for the 875 call = \$7.40 in premium collected

Net Debit: \$73.55 in premium paid – \$7.40 in premium collected = \$66.15 net debit

Breakeven Prices: \$683.85 and \$816.15 (\$750 – \$66.15 and \$750 + \$66.15)

Maximum Profit Potential: (\$125-wide spreads – \$66.15 net debit) x 100 = \$5,885

Maximum Loss Potential: \$66.15 debit x 100 = \$6,615

In this example, both spreads have equal strike widths, so the profit potential is the same on both sides. Let’s see what happens!

### Iron Fly #3 Trade Results

As we can see here, the iron fly in this example did not do well because the stock price remained between the breakeven points as time passed. At expiration, the stock price was trading for \$737.60, which means the long 750 put was only worth \$12.40 while all of the other options expired worthless. Consequently, the iron fly’s expiration value consists of the long 750 put’s value of \$12.40. With an initial purchase price of \$66.15, the iron fly buyer realizes a loss of \$5,375: (\$12.40 iron fly expiration value – \$66.15 purchase price) x 100 = -\$5,375.

Since the long put is in-the-money at expiration, the trader would end up with -100 shares of stock if the put was held through expiration. To avoid a share assignment, the long 750 put would need to be sold before expiration.

## Final Word

• The long iron butterfly is essentially the combining of a long straddle and a short strangle.
• Additionally, this strategy can be thought of as buying a call spread and put spread with the purchased options having the same strike price.
• This strategy profits from either upside or downside movement; it will lose money in neutral markets.
• Max loss is the net debit paid; max profit is (Strike Width of Widest Spread – Debit Paid) x 100

## Long Straddle Explained – The Ultimate Guide with Visuals

The long straddle is an option strategy that consists of buying a call and put on a stock with the same strike price and expiration date. Since the purchase of an at-the-money call is a bullish strategy, and buying a put is a bearish strategy, combining the two into a long straddle technically results in a directionally neutral position. However, a long straddle requires a significant shift in the stock price to profit, though the direction doesn’t matter. Because of this, a buying straddles is essentially a long or positive gamma strategy.

When buying straddles, profits come from large movements in the stock price or increases in implied volatility, as long as too much time doesn’t pass before either of those events happen.

TAKEAWAYS

• A straddle consists of buying both a call and put option on the same security, strike price, and expiration date.

• In a long straddle, both the call and put options are purchased

• Long straddles benefit from either large upside or downside movements in an underlying.

• At-the-money straddles on near-term options assist traders in forecasting a stock’s expected move.

## Options Strategy Characteristics

Let’s go over the long straddle strategy’s general characteristics:

➥Max Profit Potential: Unlimited

➥Max Loss Potential: Net Debit x 100

➥Expiration Breakeven

Upper Breakeven = Strike Price + Debit Paid

Lower Breakeven = Strike Price – Debit Paid

To demonstrate these characteristics in action, let’s take a look at a basic example.

## Long Straddle Profit/Loss Potential at Expiration

In the following example, we’ll construct a long straddle from the following option chain:

In this case, we’ll buy the 250 call and 250 put. Let’s also assume the stock price is \$250 when entering the trade.

Initial Stock Price: \$250

Long Strikes Used: 250 put, 250 call

250 Put Purchase Price: \$15.10

250 Call Purchase Price: \$15.20

Total Debit Paid: \$15.10 + \$15.20 = \$30.30

The following visual describes the potential profits and losses at expiration when buying this particular straddle:

As illustrated here, a long straddle realizes the maximum loss potential when the stock price is trading exactly at the long strike at expiration. Because of this, achieving maximum loss on a long straddle is very unlikely. Regarding profits, we can see that a large movement in the stock price is required for the straddle to be profitable at expiration. In this example, the stock price has to move ±12% in either direction just to break even, which makes buying straddles a low probability trade.

The table below explains the performance of this position based on various scenarios at expiration:

Stock Price Below the Lower Breakeven Price (\$219.70)

The 250 call expires worthless but the long 250 put has more intrinsic value than the entire straddle was purchased for (\$30.30), and therefore the straddle buyer realizes profits.

Stock Price Between the Lower Breakeven and the Long 250 Put (\$219.70 to \$249.99)

The 250 call expires worthless. The 250 put has intrinsic value, but not more than the premium the trader paid when buying the straddle. Consequently, the long straddle position is not profitable.

Stock Price Exactly at \$250

Both the 250 call and 250 put expire worthless. The long straddle trader ends up with the maximum loss potential.

Stock Price Between the Long Call Strike and the Upper Breakeven (\$250.01 to \$280.30)

The 250 put expires worthless. The 250 call has intrinsic value, but not more than the premium the trader paid when buying the straddle. Consequently, the long straddle position is not profitable.

Stock Price Above the Upper Breakeven (\$280)

The 250 put expires worthless but the 250 call has more intrinsic value than the straddle was bought for, and therefore the long straddle position is profitable. Since the stock price can rise indefinitely, the long call (and consequently the entire long straddle) has unlimited profit potential.

So, you know how the potential outcomes at expiration, but what about before expiration? Understanding how profits and losses occur when buying straddles can be explained by the position’s option Greeks (if you want to improve your understanding of option risks, read our ultimate guides on the option Greeks).

The option Greeks describe the various risks of an option position. In the following table, we’ll discuss the general Greek exposures of a long straddle position.

DeltaGenerally speaking, a long straddle’s position delta will start near zero if the trader buys an at-the-money straddle (e.g. a -50 delta long put and a +50 delta long call). However, as the stock price changes, a long straddle will take on a positive or negative delta position.

GammaPositive – When the stock price rises, a long straddle becomes directionally long because the delta of the long call becomes more significant while the delta of the long put diminishes. On the other hand, when the stock price falls, a long straddle becomes directionally short because the delta of the long put becomes more significant while the delta of the long call diminishes. The concept of positive gamma will be discussed further in the example trades.

ThetaNegative – The extrinsic value of options decays as time passes, which is harmful to straddle buyers.

VegaPositive – An increase in implied volatility suggests an increase in option prices, which is excellent for straddle buyers. On the other hand, a decrease in implied volatility suggests falling option prices, which is detrimental to straddle buyers.

When buying straddles, the main profit drivers are increases in implied volatility and large stock price changes.

As time passes, the extrinsic value of options decays away, leading to losses for option buyers. Consequently, to be profitable when buying straddles, large stock price movements or increases in implied volatility must occur in short periods of time.

Nice job! Next, we’ll go through some visualized trade examples to observe the performance of long straddles through time.

In this section, we’re going to visualize the performance of long straddles relative to changes in the stock price. Note that we don’t specify the underlying, since the same concepts apply to long straddles on any stock.

Additionally, each example demonstrates the performance of a single positionWhen trading more contracts, the profits and losses in each case would be magnified by the number of straddles traded.

Let’s do it!

The first example we’ll look at is a situation where the stock price trades in a tight range after an at-the-money straddle is purchased.

Initial Stock Price: \$210.72

Initial Implied Volatility: 15%

Strikes and Expiration: 211 put and 211 call expiring in 77 days

Straddle Purchase Price: \$5.46 for the put and \$4.32 for the call = \$9.78 total debit paid

Breakeven Prices: \$201.22 and \$220.78 (\$211 – \$9.78 and \$211 + \$9.78)

Maximum Profit Potential: Unlimited

Maximum Loss Potential: \$9.78 total debit x 100 = \$978

Let’s see what happens!

As you can see, buying straddles is not profitable when the stock price doesn’t rise or fall quickly with magnitude. In this case, the stock price traded near the long strike the entire time, leading to losses from time decay. Additionally, implied volatility remained around 15% the entire period, so profits from an implied volatility increase didn’t occur.

In this example, the straddle price continously fell. To lock in the profits or losses on a long straddle position, the long options can be simultaneously sold at their current prices. For example, if the trader in this position sold the straddle for \$4.00, they would have locked in a \$578 loss: (\$4.00 sale price – \$9.78 purchase price) x 100 = -\$578.

At expiration, the stock price was above \$211, which means the long call was in-the-money and the long put was out-of-the-money. However, the long 211 call only had \$1.50 of intrinsic value at expiration, which results in a \$828 loss for the straddle buyer: (\$1.50 straddle value at expiration – \$9.78 initial purchase price) x 100 = -\$828.

At expiration, the trader would end up with +100 shares of stock if the in-the-money 211 call was held through expiration. To avoid a stock position, the call would need to be sold before expiration.

The example above demonstrates what can go wrong when buying straddles. In the next demonstration, we’ll look at a scenario where a long straddle position turns into a big winner.

In the next example, we’ll look at how a long straddle performs when the stock price falls significantly. In particular, we’ll examine a long straddle position on a stock in late 2008.

Initial Stock Price: \$126.20

Initial Implied Volatility: 23%

Strikes and Expiration: 126 put and 126 call expiring in 78 days

Straddle Purchase Price: \$5.18 for the put + \$5.07 for the call = \$10.25 total debit paid

Breakeven Prices: \$115.75 and \$136.25 (\$126 – \$10.25 and \$126 + \$10.25)

Maximum Profit Potential: Unlimited

Maximum Loss Potential: \$10.25 debit x 100 = \$1,025

Let’s see how the trade performed:

As you can see here, the long straddle position performed poorly in the first 40 days of the period. However, the stock price suddenly collapsed from \$125 to \$95. At the same time, implied volatility in the expiration cycle of the long straddle spiked to over 75%. Consequently, the price of the 126 straddle surged in price to \$35. With an initial purchase price near \$10, the profit is \$2,500 per long straddle when the straddle is worth \$35: (\$35 straddle price – \$10 purchase price x 100) = +\$2,500.

If the trader wanted to take profits before expiration, the straddle can be sold at its current price. For example, if the straddle was sold for \$25, the trader would have locked in \$1,475 in profits: (\$25 sale price – \$10.25 initial purchase price) x 100 = +\$1,475.

At expiration, the stock price was \$31 below the straddle’s strike price of \$126, which translates to \$31 of intrinsic value for the 126 put and \$0 of intrinsic value for the 126 call. Because of this, the expiration profit for the straddle buyer is \$2,075: (\$31 expiration straddle value – \$10.25 initial purchase price) x 100 = +\$2,075.

If held through expiration, the long 126 put would become -100 shares of stock. So, if the trader wanted to avoid a stock position, the long 126 put would need to be sold before expiration.

## Changes in a Long Straddle's Directional Exposure (Positive Gamma Demonstration)

In addition to demonstrating the potential profits from buying straddles, this example serves as an excellent demonstration of how a straddle’s delta can change rather quickly. As mentioned earlier, a long straddle position has positive gamma, which means that as the stock price trends in one direction, the delta (directional exposure) of the position will grow in the same direction. For example, if the stock price increases, the delta of a long straddle position will become more positive, resulting in a bullish position. Conversely, when the stock price decreases, the delta of a long straddle position will grow more negative, resulting in a bearish position.

Let’s visualize the concept of positive gamma using the same example as above:

As visualized here, the position delta of the long straddle moves with the stock price. When the stock price increases, the position delta becomes more positive, which means the position is more bullish. When the stock price decreases, the position delta becomes more negative, which means the position is more bearish. Intuitively, this should make sense because the profit potential of a long straddle occurs when the stock price changes significantly in one direction.

Therefore:

➜ When the stock price falls below the strike price, the position becomes bearish because the ideal scenario is for the stock price to continue falling.

➜ When the stock price rises above the strike price, the position becomes bullish because the best case scenario is for the stock price to fall to continue rising.

In this example, the delta of the long straddle turned negative when the stock price fell. As a result, further stock price decreases lead to profits for the straddle buyer, explaining why a long straddle benefits from continued stock price movements in one direction.

Lastly, at expiration, the straddle’s position delta is -100. Since an in-the-money long put expires to -100 shares of stock, the position delta of -100 makes sense.

In the final example, we’ll look at an example where a straddle buyer doesn’t make or lose much money.

In the final example, we’ll look at a scenario where a long straddle trader doesn’t make or lose much money, which occurs when the stock price is near one of the straddle’s breakeven prices at expiration.

Initial Stock Price: \$210.56

Strikes and Expiration: 211 put and 211 call expiring in 60 days

Straddle Purchase Price: \$4.83 for the put + \$3.51 for the call = \$8.34 total debit paid

Breakeven Prices: \$202.66 and \$219.34 (\$211 – \$8.34 and \$211 + \$8.34)

Maximum Profit Potential: Unlimited

Maximum Loss Potential: \$8.34 net debit x 100 = \$834

Let’s see what happens!

As we can see here, the stock price fell significantly after the long straddle was entered. As a result, the position had profits over the entire period. At the highest point, the profit on the long straddle was approximately \$1,700: (\$25 straddle price – \$8.34 purchase price) x 100 = +\$1,666.

However, the stock price rallied back to the long straddle’s lower breakeven and the trade had a small loss at expiration. The only way the trader could have secured the profits on the position would have been to sell the straddle while it was profitable.

At expiration, since the long 211 put was in-the-money, the trader would end up with -100 shares of stock if the put was held through expiration. If the trader wanted to avoid a stock position, the long 211 put would need to be sold before it expired.

## Final Word

Congratulations! You should now be much more confident with how the long straddle works as a trading strategy!

Let’s review what we have learned:

• The long straddle consists of purchasing one put and one call option, usually at-the-money.
• Since we are buying options, the most we can ever lose is the total debit paid.
• The max profit in a long straddle is unlimited; the call has no cap.
• The delta of straddles change quickly with fluctuations in the market.

## Long Strangle Option Strategy with Visuals – The Ultimate Guide

The long strangle is an options strategy that consists of buying an out-of-the-money call and put on a stock in the same expiration cycle.

Since the purchase of a call is a bullish strategy and buying a put is a bearish strategy, combining the two into a strangle results in a directionally neutral position.

However, even though a strangle is not directionally specific (bullish or bearish), the strategy requires a significant stock price change in either direction or an increase in implied volatility to profit. In other words, buying a strangle is bullish AND bearish.

If a large stock price movement or increase in implied volatility does not occur, the position’s value will slowly decrease, leading to losses for the strangle buyer.

TAKEAWAYS

• The long strangle is a directional trade; it profits when the stock moves up or down by a significant amount.

• The strategy consists of buying both a call and put option at the same strike price and expiration.

• Maximum loss for the long strangle is the total debit paid.

• Maximum profit is unlimited as the long call has no cap.

## Long Strangle Options Strategy Characteristics

Let’s look at the long strangle’s general characteristics:

Max Profit Potential: Unlimited

Max Loss Potential: Debit Paid x 100

Expiration Breakeven

Upper Breakeven = Call Strike Price + Total Debit Paid

Lower Breakeven = Put Strike Price – Total Debit Paid

Estimated Probability of Profit:

Less than 50% because a significant stock price change or an increase in implied volatility is required to profit.

To explain these characteristics further, let’s look at a basic example.

## Long Strangle Profit/Loss Potential at Expiration

In the following example, we’ll construct a long strangle position using the following option chain:

In this case, we’ll buy the 190 put and the 210 call. Let’s also assume the stock price is trading for \$200 when the strangle is purchased.

Initial Stock Price: \$200

Long Strikes/Purchased Options Used: 190 put, 210 call

190 Put Purchase Price: \$3.78

210 Call Purchase Price: \$4.31

Total Debit Paid\$3.78 + \$4.31 = \$8.09

The following visual describes the potential profits and losses of this position at expiration:

### Long Strangle at Expiration

As illustrated in this visual, a long strangle has significant profit potential when the stock price makes a large move in either direction. However, the low risk and high reward nature of a long strangle suggests that such a movement is not probable. In this particular example, the stock price must move ±18.09 for the position to break even at expiration, which represents nearly a 20% move in either direction.

In this section, we’re going to visualize the performance of real long strangles that recently traded in the market. Note that we don’t specify the underlying, since the same concepts apply to long strangles on any stock. Additionally, each example demonstrates the performance of a single strangle positionWhen trading more contracts, the profits and losses in each case would be magnified by the number of strangles traded.

Let’s do it!

## Trade Example #1: Maximum Loss Strangle Purchase

The first example we’ll look at is a situation where a hypothetical trader buys a strangle with a call and put that have deltas near ±0.20. With a delta near ±0.20, the call and put both have an estimated 20% probability of expiring in-the-money, respectively.

Because of this, the strangle as a whole has an approximate 40% probability of expiring in-the-money, which translates to a 60% probability of expiring out-of-the-money (max loss for the strangle buyer).

Initial Stock Price: \$212.44

Initial Implied Volatility: 14%

Strikes and Expiration: 201 put and 219 call expiring in 63 days

Strangle Purchase Price: \$1.75 for the put and \$0.83 for the call = \$2.58 total debit

Breakeven Prices: \$198.42 and \$221.58 (\$201 – \$2.58 and \$219 + \$2.58)

Maximum Profit Potential: Unlimited

Maximum Loss Potential: \$2.58 net debit x 100 = \$258

Let’s see how this trade performed:

In this example, we can see that the price of the 201/219 strangle decays continously over time because the stock price remains between the long strikes. Additionally, implied volatility remained flat because the stock price did not move violently in either direction. At expiration, both options expire worthless, resulting in the maximum loss potential of \$258 for the strangle buyer.

If the trader wanted to lock in losses at any point, they could have sold the strangle at its current price. For example, if the trader sold the strangle for \$1.50, they would have locked in a loss of \$108: (\$1.50 sale price – \$2.58 purchase price) x 100 = -\$108.

## Trade Example #2: Profitable Long Strangle

In this example, we’ll examine the performance of a long strangle when the stock price collapses through the long put strike.

Initial Stock Price: \$524

Initial Implied Volatility: 26%

Strikes and Expiration: 495 put and 555 call expiring in 39 days

Strangle Purchase Price: \$6.35 for the put and \$6.20 for the call = \$12.55 total debit paid

Breakeven Prices: \$482.45 and \$567.55 (\$495 – \$12.55 and \$555 + \$12.55)

Maximum Profit Potential: Unlimited

Maximum Loss Potential: \$12.55 net debit x 100 = \$1,255

Let’s see how the trade performed:

This time around, we can see that when the stock price falls significantly, the price of the strangle surges because the price of the long put explodes. Additionally, when the stock price falls significantly, implied volatility tends to spike, which indicates higher option prices across the board.

At the highest point, the 495/555 strangle is worth \$43.85, which represents a profit of \$3,130: (\$43.85 strangle price – \$12.55 purchase price) x 100 = +\$3,130. Unfortunately, the stock price rallied back and the strangle ended up expiring worthless, but this example still demonstrates how a significant move in the stock price leads to profits for a strangle buyer.

## Final Word

Congratulations! You should now be much more comfortable with how buying strangles works as an options trading strategy.

Let’s review what we have learned:

• To profit, the long strangle requires a strategy requires a significant stock price change in either direction or an increase in implied volatility to profit.
• If the underlying does not change in value, overtime the options will both decay.
• Max loss on the long strangle is the debit paid; max profit is unlimited

## Long Butterfly Spread Explained – Options Strategy with Visuals

The long butterfly spread is a limited-risk, neutral options strategy that consists of simultaneously buying a call (put) spread and selling a call (put) spread that share the same short strike price. All options are in the same expiration cycle. Additionally, the distance between the short strike and long strikes is equal for standard butterflies.

Butterflies are used when a trader believes the stock price will trade near a certain price in the future, as a butterfly’s maximum profit potential occurs when the stock price trades at the position’s short strike at expiration. Regarding losses, butterflies usually have very low risk because they are cheap, which is represented by the fact that they generally have a low probability of profit. However, butterflies can carry more risk when wider strikes are used.

Lastly, butterflies can be constructed with all calls or puts without changing the risk-reward profile of the position. For example, both of the following long butterfly positions will have the same potential profits and losses:

Call Butterfly:

Put Butterfly:

TAKEAWAYS

• The long butterfly consists of three parts: buying one call at a lower strike price, selling two calls with a higher strike price and buying one call with a higher strike price.

• To make it a “put” iron butterfly, simply use puts instead of calls for the above inputs.

• The max profit for this trade is the width of the spread – debit paid.

• The max loss is always the total debit paid

## Long Butterfly Options Strategy - General Characteristics

Let’s go over the strategy’s general characteristics:

➥Max Profit Potential:

Long Call Butterfly: (Width of Long Call Spread – Debit Paid) x 100

Long Put Butterfly: (Width of Long Put Spread – Debit Paid) x 100

➥Max Loss Potential: Debit Paid x 100

➥Expiration Breakevens:

Upper Breakeven

Long Call Butterfly: Short Strike + (Width of Long Call Spread – Debit Paid)

Long Put Butterfly: Higher Long Put Strike – Debit Paid

Lower Breakeven

Long Call Butterfly: Lower Long Call Strike + Debit Paid

Long Put Butterfly: Short Strike – (Width of Long Put Spread – Debit Paid)

➥Position After Expiration

If the call or put butterfly is entirely in-the-money at expiration, the exercise and assignments will offset since there are an equal number of long and short options.

If the butterfly is partially in-the-money, the trader will end up with a stock position at expiration.

### Here are the resulting stock positions for a partially in-the-money long call butterfly at expiration:

1 Long Call In-the-Money: +100 shares of stock

1 Long Call and 2 Short Calls In-the-Money: -100 shares of stock

Here are the resulting stock positions for a partially in-the-money put butterfly at expiration:

1 Long Put In-the-Money: -100 shares of stock

1 Long Put and 2 Short Puts In-the-Money: +100 shares of stock

To demonstrate these characteristics in action, let’s take a look at a basic butterfly example.

## Long Butterfly Profit/Loss Potential at Expiration

In the following example, we’ll construct a long call butterfly from the following option chain:

To construct a long call butterfly, we’ll have to buy a call spread and sell a call spread that share the same short strike. In other words, we’ll buy one call, sell two calls at a higher strike price, and purchase one call at an even higher strike price.

In this case, we’ll buy the 250 call, sell two of the 300 calls, and buy one of the 350 calls. Let’s also assume the stock price is trading for \$300 when we put this trade on:

Initial Stock Price: \$300

Short Strike: \$300 short call (x2)

Long Strikes: \$250 long call, \$350 long call

Credit Received for Short Calls: \$12.14 x 2 = \$24.28

Debit Paid for Long Calls: \$50.42 + \$0.92 = \$51.34

Total Price Paid: \$51.34 paid – \$24.28 received = \$27.06

Before we move on, you’ll notice that the put butterfly using the same strike prices has the same cost:

Long 350 put for \$50.89 + Long 250 put for \$0.39 = \$51.28 debit

Short two 300 puts: \$12.11 x 2 = \$24.22 credit

Net Debit: \$51.28 debit – \$24.22 credit = \$27.06

Since both the call and put butterfly have the same price and strike widths, they have the same maximum loss potential. Additionally, since they have the same strike widths, they must also have the same profit potential. So, put and call butterflies are identical. For the remainder of this guide, we’ll just use long call butterflies in the examples to keep things simple.

Moving our focus back to the long call butterfly example, the following visual describes the position’s potential profits and losses at expiration:

### Long Butterfly at Expiration

As illustrated above, the long call butterfly achieves maximum profit when the stock price is trading at the short strike at expiration, which is a very low probability event. So, making full profit on a long butterfly position should not be expected. With that said, there’s still plenty of profit potential if the stock price is trading somewhere near the short strike at expiration.

Regarding loss potential, the butterfly in this example has a maximum loss potential of \$2,706, which is the debit paid x 100. Maximum loss occurs when the stock price is above or below one of the long call strikes at expiration.

Great job! You’ve learned the general characteristics of the long butterfly strategy. Now, let’s go through some visual trade examples to see how the strategy performs through time.

## Long Call Butterfly Trade Examples

To visualize the performance of the long call butterfly strategy relative to the stock price, let’s look at a few examples of some options that recently traded. Note that we don’t specify the underlying because butterfly concepts are transferrable to other stocks in the market. Additionally, each example demonstrates the performance of a single positionWhen trading more contracts, the profits and losses in each case will be magnified by the number of butterflies traded.

Let’s do it!

## Trade Example #1: Breakeven Butterfly Purchase

The first example we’ll look at is a scenario where a trader buys a butterfly, but the stock price is near one of the breakevens at expiration.

Initial Stock Price: \$105.79

Strikes and Expiration: Short two 106 calls; Long 98 call and 114 call; All options expiring in 45 days

Premium Collected for Short Calls: \$2.50 x 2 =  \$5.00 in premium collected

Premium Paid for Long Calls: \$8.46 for the 98 call + \$0.14 for the 114 call = \$8.60 in premium paid

Net Debit: \$8.60 in premium paid – \$5.00 in premium collected = \$3.60 net debit

Breakeven Prices

Lower Breakeven: \$98 long call strike + \$3.60 debit paid = \$101.60

Upper Breakeven: \$106 short strike + (\$8-wide call spread – \$3.60 debit) = \$110.40

Maximum Profit Potential: (\$8-wide long call spread – \$3.60 debit paid) x 100 = \$440

Maximum Loss Potential: \$3.60 debit x 100 = \$360

Let’s see how the trade performed:

As illustrated here, the 98/106/114 long call butterfly performed well over most of the period because the stock price was relatively close to the short strike, resulting in profits from time decay.

If the trader wanted to lock in profits, they could have sold the butterfly at its price at any point in the trade. If the trader sold the butterfly for \$4.50, they would have locked in a profit of \$90: (\$4.50 sale price – \$3.60 initial purchase price) x 100 = +\$90.

Unfortunately, the stock price was above the upper breakeven price at expiration and the call butterfly suffered a very small loss.

Regarding a share assignment, this particular trader would have been assigned -100 shares of stock if they did not close one of the in-the-money short calls before expiration. Closing one of the in-the-money short calls would leave the trader with one in-the-money long and short call, which would offset in terms of exercise and assignment. Either way, there’s always a chance that the trader is assigned early on the in-the-money short calls before expiration.

Next, we’ll take a look at a scenario where a butterfly realizes the maximum potential loss.

In the following example, we’ll investigate a situation where the stock price rises continuosly and is above the higher long call strike price of a butterfly at expiration.

Initial Stock Price: \$74.44

Strikes and Expiration: Short two 75 calls; Long 70 call and 80 call; All options expiring in 67 days

Premium Collected for Short Calls: \$3.10 x 2 =  \$6.20 in premium collected

Premium Paid for Long Calls: \$6.15 for the 70 call + \$1.28 for the 80 call = \$7.43 in premium paid

Net Debit: \$7.43 in premium paid – \$6.20 in premium collected = \$1.23 net debit

Breakeven Prices

Lower Breakeven: \$70 long call strike + \$1.23 debit paid = \$71.23

Upper Breakeven: \$75 short strike + (\$5-wide call spread – \$1.23 debit) = \$78.77

Maximum Profit Potential: (\$5-wide long call spread – \$1.23 debit paid) x 100 = \$377

Maximum Loss Potential: \$1.23 debit x 100 = \$123

Let’s take a look at what happens:

As we can see here, the long call butterfly did not do well because the stock price increased significantly over the trade period. At expiration, the call butterfly was fully in-the-money. Consequently, the buyer of the call butterfly realized the maximum loss potential since the butterfly wasn’t worth anything at expiration.

Regarding a share assignment, all of the in-the-money calls would offset at expiration. However, there’s a chance that the trader in this example is assigned early on the two in-the-money short calls before expiration.

## Trade Example #3: Highly Profitable Butterfly Purchase

In the final example, we’ll look at a scenario where a long butterfly trader makes almost full profit at expiration.

Initial Stock Price: \$752

Strikes and Expiration: Short two 750 calls; Long 700 call and 800 call; All options expiring in 46 days

Premium Collected for Short Calls: \$37.30 x 2 =  \$74.60 in premium collected

Premium Paid for Long Calls: \$68.40 for the 700 call + \$16.75 for the 800 call = \$85.15 in premium paid

Net Debit: \$85.15 in premium paid – \$74.60 in premium collected = \$10.55 net debit

Breakeven Prices

Lower Breakeven: \$700 long call strike + \$10.55 debit paid = \$710.55

Upper Breakeven: \$750 short strike + (\$50-wide call spread – \$10.55 debit) = \$789.45

Maximum Profit Potential: (\$50-wide long call spread – \$10.55 debit) x 100 = \$3,945

Maximum Loss Potential: \$10.55 debit x 100 = \$1,055

Let’s see what happens!

In this example, the 700/750/800 long call butterfly performed very well because the stock price was near the short strike at expiration.

More specifically, the stock price was trading for \$737.60 at expiration, resulting in an expiration value of \$37.60 for the 700/750/800 call butterfly (since the 700 call expired worth its intrinsic value of \$37.60 and the other calls expired worthless).

Since the initial purchase price was \$10.55, the expiration profit would be \$2,705: (\$37.60 expiration value – \$10.55 purchase price) x 100 = +\$2,705.

At expiration, this position would expire to +100 shares of stock since only the 700 call expired in-the-money. If the trader did not want to be long shares after expiration, the long 700 call would need to be sold before expiration.

## Final Word

Congratulations! You should now feel much more comfortable with how the long butterfly works as a trading strategy. Let’s recap what we learned:

• The long butterfly is a limited risk, market neutral trade.
• To construct a long call butterfly, we’ll have to buy a call spread and sell a call spread that share the same short strike.
• Max profit is the spread width, minus the debit paid.
• Max loss is the debit paid.

## Short Iron Butterfly Explained – Examples with Visuals

A short iron butterfly position can be conceptualized in two ways:

2) Simultaneously selling a call spread and put spread with the same short strike price.

The iron fly strategy is very similar to a short straddle, except an iron fly has less risk due to using spreads as opposed to naked short options.

TAKEAWAYS

• The short iron butterfly consists of 4 options: 1 long call, 1 short call; 1 long put, 1 short put.

• In this strategy, all 4 options must be of the same expiration.

• The total credit received is the maximum profit.

• For the short iron butterfly, maximum loss is: (Strike Width of Widest Spread – Net Credit Received) x 10

## Short Iron Butterfly General Characteristics

➥Max Profit Potential: Net Credit Received x 100

➥Max Loss Potential: (Strike Width of Widest Spread – Net Credit Received) x 100

➥Expiration Breakevens:

Upper Breakeven = Short Strike + Net Credit Received

Lower Breakeven = Short Strike – Net Credit Received

To demonstrate these characteristics in action, let’s take a look at a basic example and visualize the iron butterfly strategy’s potential profits and losses at expiration.

## Short Iron Butterfly Profit/Loss Potential at Expiration

In the following example, we’ll construct a short iron butterfly from the following option chain:

In this case, we’ll sell the 300 call and 300 put for a total credit of \$24.25, and we’ll buy the 250 put and 350 call for a total debit of \$1.31. Let’s also assume the stock price is trading for \$300 when we put this trade on:

Initial Stock Price: \$300

Short Strikes: \$300 short put, \$300 short call

Long Strikes: \$250 long put, \$350 long call

Credit Received for Short Options: \$12.14 + \$12.11 = \$24.25

Debit Paid for Long Options: \$0.39 + \$0.92 = \$1.31

Total Credit Received\$24.25 Credit – \$1.31 Debit = \$22.94

The following visual describes the position’s potential profits and losses at expiration:

### Iron Butterly Chart

As illustrated above, the short iron butterfly strategy realizes its maximum profit potential when the stock price is trading at the short strike at expiration, which has a low probability of occurring. However, since the short iron butterfly can collect a lot of premium, making partial profits on a short iron butterfly still results in healthy profits compared to making full profit on strategies that collect less premium (such as a short strangle).

Additionally, you’ll notice that a short iron butterfly has a similar risk profile to a short straddle, except the risk of a short iron butterfly is limited beyond the long options.

Regarding loss potential, both the short call spread and put spread are \$50 wide. Because of this, the maximum potential loss is: (\$50 strike width – \$22.94 credit received) x 100 = \$2,706. However, if the call spread were \$75 wide (e.g. 300 short call and 375 long call), the maximum loss potential of this iron fly would be: (\$75 strike width – \$22.94 credit received) x 100 = \$5,206. So, the loss potential of a short iron fly always depends on the width of the wider spread.

When each spread has the same width, the risk of loss is equal on both sides.

Nice job! You’ve learned the general characteristics of the short iron fly strategy. Now, let’s go through some visual trade examples to solidify your knowledge of how selling an iron butterfly works in practice.

## Short Iron Fly Trade Examples

To visualize the performance of the iron fly strategy relative to the stock price, let’s look at a few examples of some iron butterflies that recently traded. Note that we don’t specify the underlying, since the same concepts apply to short iron flies on any stock. Additionally, each example demonstrates the performance of a single iron fly positionWhen trading more contracts, the profits and losses in each case will be magnified by the number of iron flies traded.

Let’s do it!

## Trade Example #1: Breaking Even

The first example we’ll look at is a scenario where a trader sells an iron fly, but the stock price is near one of the breakeven prices at expiration.

Initial Stock Price: \$105.79

Strikes and Expiration: Short 106 Call and Put; Long 97 Put and 112 Call; All options expiring in 45 days

Premium Collected for Short Options: \$3.04 for the 106 put + \$2.50 for the 106 call = \$5.54 in premium collected

Premium Paid for Long Options: \$0.77 for the 97 put + \$0.35 for the 112 call = \$1.12 in premium paid

Net Credit: \$5.54 in premium collected – \$1.12 in premium paid = \$4.42 net credit

Breakeven Prices: \$101.58 and \$110.42 (\$106 – \$4.42 and \$106 + \$4.42)

Maximum Profit Potential: \$4.42 net credit x 100 = \$442

Maximum Loss Potential (Upside): (\$6-wide call spread – \$4.42 net credit) x 100 = \$158

Maximum Loss Potential (Downside): (\$9-wide put spread – \$4.42 net credit) x 100 = \$458

As mentioned earlier, the maximum loss potential of an iron fly depends on the wider spread. In this example, the short call spread is \$6 wide, and the short put spread is \$9 wide. Because of this, the maximum loss potential of this iron fly occurs when the stock price collapses through the short put spread. More specifically, this trade has \$158 in loss potential on the upside and \$458 in potential losses on the downside. Consequently, this particular short iron fly position has a slightly bullish bias because the trader would prefer the stock to rise instead of fall (if the stock was to move in one direction at all).

Let’s see what happens!

As we can see, this short iron fly was profitable almost the entire period because the stock price was between the breakeven prices. As the days passed, the 106 call and put decayed in price more than the long 97 put and 112 call. Because of this, the position was profitable. However in the final days before expiration, the stock price rallied above the upper breakeven price of \$110.42, leading to losses on the position.

More specifically, the stock price was trading for \$110.64 at expiration, which means the loss on the iron fly was only \$22: (\$110.42 upper breakeven – \$110.64 final stock price) x 100 = -\$22The strategy is a net loser because the 106 short call expires with \$4.64 of intrinsic value when \$4.42 was collected for selling the iron fly. Since the position is worth more than it was sold for initially, the trader incurs losses.

In this example, the position was profitable for most of the period, which means the position could have been closed for a profit. If the trader wanted to lock in profits before expiration, an iron fly could be closed by purchasing the short call and put, and selling the long call and put.

Regarding a share assignment, this particular trader would be assigned -100 shares of stock if they did not close the in-the-money short call before expiration. If the trader did not want a short stock position, the short call would need to be bought back before expiration. However, there’s always a chance that the trader could get assigned early on the short call.

Ok, so you’ve seen a short iron fly that breaks even. Next, we’ll take a look at a scenario where a short iron fly realizes the maximum potential loss.

## Trade Example #2: Maximum Loss Iron Fly

In the following example, we’ll investigate a situation where the stock price rises continuosly and is above the long call strike price at expiration.

Initial Stock Price: \$74.44

Strikes and Expiration: Short 75 Put and Call; Long 70 Put and 80 Call; All options expiring in 39 days

Premium Collected for Short Options: \$2.80 for the 75 put + \$2.29 for the 75 call = \$5.09 in premium collected

Premium Paid for Long Options: \$0.95 for the 70 put + \$0.67 for the 80 call = \$1.62 in premium paid

Net Credit: \$5.09 in premium collected – \$1.62 in premium paid = \$3.47 net credit

Breakeven Prices: \$71.53 and \$78.47 (\$75 – \$3.47 and \$75 + \$3.47)

Maximum Profit Potential: \$3.47 net credit x 100 = \$347

Maximum Loss Potential: (\$5-wide spreads – \$3.47 net credit) x 100 = \$153

In this example, both the short call spread and short put spread are \$5 wide, so the risk is equal on both sides of the trade.

Let’s take a look at what goes wrong:

As we can see in this example, the stock price rallied from \$74.44 to over \$82.50 during the life of this short iron fly position. With an upper breakeven of \$78.47, this iron fly suffered losses. However, with a \$5-wide short call spread, the maximum value of this iron fly is \$5, which caps the iron fly seller’s losses to \$153 since the iron fly was sold for \$3.47: (\$3.47 sale price – \$5 expiration value) x 100 = -\$153.

At expiration, an in-the-money short call expires to -100 shares of stock and an in-the-money long call expires to +100 shares of stock. Consequently, there is no resulting stock position for the iron fly seller in this example.

## Trade Example #3: Highly Profitable Iron Fly

In the final example, we’ll look at a scenario where a short iron fly trader makes almost full profit at expiration. The maximum profit of an iron fly occurs when the stock price is at the short strike at expiration.

Initial Stock Price: \$752

Strikes and Expiration: Short 750 put and call; Long 625 Put and 875 Call; All options expiring in 46 days

Premium Collected for Short Options: \$36.25 for the 750 put + \$37.30 for the 750 call = \$73.55 in premium collected

Premium Paid for Long Options: \$4.50 for the 625 put + \$2.90 for the 875 call = \$7.40 in premium paid

Net Credit: \$73.55 in premium collected – \$7.40 in premium paid = \$66.15 net credit

Breakeven Prices: \$683.85 and \$816.15 (\$750 – \$66.15 and \$750 + \$66.15)

Maximum Profit Potential: \$66.15 net credit x 100 = \$6,615

Maximum Loss Potential: (\$125-wide spreads – \$66.15 net credit) x 100 = \$5,885

In this example, both spreads have equal strike widths, so the risk is the same on both sides. Note that since the maximum profit potential of this trade is greater than the maximum loss potential, this particular iron fly has less than a 50% probability of profit, in theory. Additionally, the at-the-money straddle is trading for \$73.55, indicating an “expected move” of around \$75, while the iron fly only collects only \$66.15. So, if the stock price shifted by the expected move, the position would be a loser because the stock price would be beyond one of the breakeven points.

Let’s see what happens that allows this trade to make money!

In this example, the short 750 iron fly did quite well because the stock price remained between the breakeven prices for most of the period. Additionally, the stock price was trading for \$737.50, just \$12.50 below the iron fly’s short strike. Because of this, the 750 put expired with intrinsic value of \$12.50 while all of the other options expired worthless. As a result, the net value of the iron fly at expiration is just \$12.50. With an initial sale price of \$66.15, the profit for the iron fly seller is \$5,365: (\$66.15 initial sale price – \$12.50 expiration value) x 100 = +\$5,365.

Regarding a share position, the short iron fly trader would be assigned +100 shares of stock if the short 750 put was held through expiration. Assuming the trader isn’t assigned early on the short put before expiration, the trader could avoid a share assignment by purchasing the short 750 put right before expiration.

## Final Word

Congratulations! You should now feel a lot more comfortable with the short iron butterfly strategy! Let’s review what we have learned:

• The short iron butterfly spread is a four-part options trading strategy.
• This strategy performs best in neutral markets.
• Maximum loss is calculated as (Strike Width of Widest Spread – Net Credit Received) x 100
• Maximum profit is always the net credit received.

## Short Iron Condor Explained – The Ultimate Guide

The short iron condor options strategy is a limited risk strategy consisting of simultaneously selling an out-of-the-money call spread and out-of-the-money put spread in the same expiration date cycle.

Since the sale of a call spread is a bearish strategy and selling a put spread is a bullish strategy, combining the two into a short iron condor results in a directionally neutral position. However, if the stock price moves significantly in either direction, the trade will lose money and also become directional.

The iron condor strategy is very similar to the strangle, except an iron condor has less risk due to using spreads as opposed to naked short options. When selling iron condors, profits come from the passage of time or decreases in implied volatility, as long as the stock price remains between the two breakeven prices of the position.

Care to watch the video instead? Check it out below!

TAKEAWAYS

• An iron condor consists of selling a put spread (long put/short put) and a call spread (long call/short call) at the same time.

• Both of these spreads must be of the same width and expiration.

• Iron condor’s profit when the options sold fall in value.

• Short iron condors are best suited for market-neutral traders.

• Maximum loss is greater than maximum profit for most iron condors.

• High volatility allows traders to collect greater premium from iron condors sold.

## Short Iron Condor Strategy Characteristics

➥ Max Profit Potential: Net Credit Received x 100

➥ Max Loss Potential: (Strike Width of Widest Spread – Net Credit Received) x 100

➥ Expiration Breakevens:

1. Upper Breakeven = Short Call Strike Price + Net Credit Received

2. Lower Breakeven = Short Put Strike Price – Net Credit Received

Estimated Probability of Profit:

Between 50-99% depending on the strikes chosen. The further the short strikes are from the stock price, the higher the probability of profit. However, higher probability of profit comes at the cost of less potential reward.

To demonstrate these characteristics in action, let’s take a look at a hypothetical example to visualize the iron condor strategy’s potential profits and losses at expiration.

## P/L Potential at Expiration

In the following example, we’ll construct a short iron condor from the following option chain:

In this case, we’ll sell the 450 put and the 550 call, and buy the 400 put and 600 call. Let’s also assume the stock price is trading for \$500 when entering the position:

Initial Stock Price: \$500

Short Strikes: \$450 short put, \$550 short call

Long Strikes: \$400 long put, \$600 long call

Credit Received From Short Options: \$6.15 (450 put) + \$7.89 (550 call) = \$14.04

Debit Paid for Long Options: \$0.72 (400 put) + \$1.94 (600 call) = \$2.66

Total Credit Received: \$14.04 Credit Received – \$2.66 Debit Paid = \$11.38

The following visual describes the potential profits and losses at expiration when selling this particular iron condor:

### Iron Condor Chart

As illustrated above, the short iron condor strategy realizes its maximum profit potential when the stock price is between the short strikes at expiration, and amounts to the total credit received for selling each spread (multiplied by 100). Additionally, you’ll notice that a short iron condor has a similar risk profile to a short strangle, except the risk of a short iron condor is limited beyond the long options that are purchased.

Regarding loss potential, both the short call spread and short put spread are \$50 wide. Because of this, the maximum potential loss is: (\$50 strike width – \$11.38 credit received) x 100 = \$3,862. However, if the call spread were \$100 wide (e.g. 550 short call and 650 long call), the maximum loss potential of this iron condor would be: (\$100 strike width – \$11.62 credit received) x 100 = \$8,862. Therefore, an iron condor’s loss potential always depends on the width of the wider spread. When each spread has the same width, the risk of loss is equal on both sides.

The last thing we’ll point out about this graph is that the breakeven prices are both above and below the stock price, which means the stock can trade in a wide range and the short iron condor can be profitable. Because of this, the selling iron condors is a high probability strategy. However, this makes sense since the maximum potential loss is greater than the maximum potential reward (in general).

At this point, you know how the outcomes at expiration when selling iron condors, but what about before expiration? Understanding how profits and losses occur when selling iron condors can be explained by the position’s option Greeks.

## Short Iron Condor Trade Examples

To visualize the performance of the iron condor strategy relative to the stock price, let’s look at a few examples of some iron condors that actually occurred. Note that we don’t specify the specific underlying because the concepts transfer to other stocks in the market. Additionally, each example demonstrates the performance of a single iron condor position.

When trading more contracts, the profits and losses in each case will be magnified by the number of iron condors traded.

Let’s do it!

## Trade Example #1: Partially Profitable Iron Condor

The first example we’ll look at is a scenario where a trader sells an iron condor, but the stock price is between the short call option and long call option at expiration. In this scenario, maximum profit will not be realized, but the strategy can still be profitable if the stock price is below the upper breakeven price.

Initial Price of The Underlying Stock: \$202.31

Strikes and Expiration: Long 182 Put and 215 Call; Short 196 Put and 208 Call; All options expiring in 72 days

Net Premium Received for Short Options: \$4.18 for the 196 put + \$2.82 for the 208 call = \$7.00 in premium collected

Net Premium Paid for Long Options: \$1.79 for the 182 put + \$0.78 for the 215 call = \$2.57 in premium paid

Net Credit: \$7.00 premium collected – \$2.57 premium paid = \$4.43 net credit

Breakeven Prices: \$191.57 and \$212.43 (\$196 – \$4.43 and \$208 + \$4.43)

Maximum Profit Potential: \$4.43 net credit x 100 = \$443

Maximum Loss Potential (Upside): (\$7-wide call spread – \$4.43 net credit) x 100 = \$257

Maximum Loss Potential (Downside): (\$14-wide put spread – \$4.43 net credit) x 100 = \$957

As mentioned earlier, the maximum loss potential of an iron condor depends on the wider spread. In this example, the short call spread is \$7 wide and the short put spread is \$14 wide. Because of this, the maximum loss potential of this iron condor occurs when the stock price collapses through the short put spread. More specifically, this trade has \$257 in loss potential on the upside and \$957 in potential losses on the downside. Consequently, this particular short iron condor position has a slightly bullish bias.

Let’s see what happens!

### Iron Condor #1 Trade Results

As we can see, this short iron condor position performed well because the stock price remained between the position’s breakeven points over the entire period.

With the price of the iron condor below the initial sale price nearly the entire period, the trader in this example had many opportunities to close the trade early for profits. To close an iron condor before expiration, a trader can simultaneously buy back the short options and sell the long options at their current prices.

For example, if the trader in this example closed the iron condor for \$3.00, they would have locked in a profit of \$143: (\$4.43 initial iron condor sale price – \$3.00 closing price) x 100 = +\$142.

At expiration, the short 208 call was worth \$2.50 because the stock price was trading for \$210.50. Since all of the other options expired worthless, the final value of the iron condor is \$2.50. With an initial sale price of \$4.43, the profit at expiration is: (\$4.43 – \$2.50) x 100 = +\$193.

Regarding a share assignment, this particular trader would be assigned -100 shares of stock if they did not close the in-the-money short call before expiration. If the trader did not want a short stock position, the short call would need to be bought back before expiration. However, there’s always a chance that the trader could get assigned early on the short call.

Ok, so you’ve seen a partially profitable iron condor example. Next, we’ll take a look at a scenario where a short iron condor realizes the maximum potential loss.

## Trade Example #2: Maximum Loss Iron Condor

In the following example, we’ll investigate a situation where the stock price rises continuosly and is above the short call spread at expiration.

Here are the details:

Initial Stock Price: \$121.45

Strikes and Expiration: Long 115 Put and 128 Call; Short 119 Put and 124 Call; All options expiring in 46 days

Premium Collected for Short Options: \$1.25 for the 119 put + \$1.05 for the 124 call = \$2.30 in premium collected

Premium Paid for Long Options: \$0.39 for the 115 put + \$0.38 for the 128 call = \$0.77 in premium paid

Net Credit: \$2.30 premium collected – \$0.77 premium paid = \$1.53 net credit

Breakeven Prices: \$117.47 and \$125.53 (\$119 – \$1.53 and \$124 + \$1.53)

Maximum Profit Potential: \$1.53 net credit x 100 = \$153

Maximum Risk: (\$4-wide spreads – \$1.53 net credit) x 100 = \$247

In this example, both the short call spread and short put spread are \$4 wide, so the risk is equal on both sides of the trade.

Let’s take a look at the trade’s performance:

### Iron Condor #2 Trade Results

As we can see in this example, the stock price rallied from \$121 to over \$130 during the duration of this trade. Since the stock price increased steadily after entering the trade, the position suffered losses and was never profitable.

At expiration, the stock price was above \$128, which means the short 124/128 call spread was entirely in-the-money (ITM) and was therefore worth \$4, which is the width of the spread.

On the other hand, the short 119/115 put spread expired worthless because both put options were out-of-the-money (OTM).

With the iron condor being worth \$4 at expiration, the trader’s loss in this example is \$247 per iron condor, as the position was sold for \$1.53 but ended at \$4.00.

## Trade Example #3: Max Profit Iron Condor

In the final example, we’ll look at a scenario where a short iron condor trader only makes full profit at expiration. The maximum profit of an iron condor occurs when the stock price is between the short strikes at expiration.

Initial Stock Price: \$574.81

Strikes and Expiration: Long 505 Put and 645 Call; Short 535 Put and 615 Call; All options expiring in 46 days

Premium Collected for Short Options: \$11.75 for the 535 put + \$10.40 for the 615 call = \$22.15 in premium collected

Premium Paid for Long Options: \$6.03 for the 505 put + \$4.47 for the 645 call = \$10.50 in premium paid

Net Credit: \$22.15 premium collected – \$10.50 premium paid = \$11.65 net credit

Breakeven Prices: \$523.35 and \$626.65 (\$535 – \$11.65 and \$615 + \$11.65)

Maximum Profit Potential: \$11.65 net credit x 100 = \$1,165

Maximum Loss Potential: (\$30-wide spreads – \$11.65 net credit) x 100 = \$1,835

Let’s see this historical trade’s performance!

### Iron Condor #3 Trade Results

In this case, the stock price collapsed immediately after the iron condor was sold. As a result, the iron condor price jumped from \$11.65 to over \$20.00, which translated to a loss of over \$850 for the iron condor seller. Fortunately, the stock price rallied back between the position’s short strikes and the position decayed as expiration approached.

Finally, at expiration, all of the options expired worthless since the stock price was between the short strikes of each spread. With an initial sale price of \$11.65, the profit on this trade is \$1,165: (\$11.65 sale price – \$0 expiration price) x 100 = +\$1,165.

Curious about the “Iron Butterfly” strategy? Learn it here!

## Final Word

Let’s review what we have learned:

• An iron condor consists of selling both a put spread (long put/short put) and a call spread (long call/short call) simultaneously
• Both of these spreads must be of the same width and expiration
• Iron condor’s profit when the options sold decrease in value
• Short iron condors are best suited for market-neutral traders
• Most iron condors have a greater than 50% chance of success
• Maximum loss is greater than maximum profit for most iron condors
• A high volatility environment allows traders to collect more premium from iron condors sold
• Iron condors with 30-60 days to expiration are ideal as this time frame allows traders to profit from time decay, or the Greek “theta

## Short Iron Condor FAQs

The long iron condor is the exact opposite trade of the short iron condor. Long iron condors are purchased for a debit while short iron condors are sold for a net credit.

When you buy an iron condor, you believe the underlying stock will make a large directional move either up or down. Short iron condors profit in a neutral market.

Short iron condors can go into expiration as long as both the short call option and short put option are safely out-of-the-money. If either of these legs is close to being in-the-money as expiration nears, it is best practice to trade out of these options.

## Short Straddle Explained – The Ultimate Guide

The short straddle is an options strategy that consists of selling call and put option on a stock with the same strike price and expiration date.

Most of the time, a short straddle trader will sell the at-the-money options. Since the sale of an at-the-money call is a bearish strategy, and selling a put is a bullish strategy, combining the two into a short straddle results in a directionally neutral position. However, as the stock price changes, the trade will become directional and can suffer significant losses.

When selling straddles, profits come from the passage of time or decreases in implied volatility, as long as the stock price remains within the breakeven points of the position. Selling straddles is very similar to selling strangles, with the only difference being that the short call and put share the same strike price.

TAKEAWAYS

• The short straddle is best suited for neutral, or “sideways” market direction.

• One short call and one short put comprise this strategy.

• The loss on this strategy is infinite  because of the short call sold.

• Total profit is limited to the credit received.

Max Profit Potential: Total Credit Received x 100

Max Loss Potential: Unlimited

Expiration Breakevens:

➥Upper Breakeven = Strike Price + Total Credit Received

➥Lower Breakeven = Strike Price – Total Credit Received

Estimated Probability of Profit: Generally between 50-60%.

To demonstrate these characteristics in action, let’s take a look at a basic example and visualize the position’s potential profits and losses at expiration.

## Short Straddle Profit/Loss Potential at Expiration

In the following example, we’ll construct a short straddle from the following option chain:

In this case, we’ll sell the 250 call and 250 put. Let’s also assume the stock price is \$250 when entering the trade.

Initial Stock Price: \$250

Short Strikes Used: 250 put, 250 call

250 Put Sale Price: \$15.10

250 Call Sale Price: \$15.20

Total Credit Received: \$15.10 + \$15.20 = \$30.30

The following visual describes the potential profits and losses at expiration when selling this particular straddle:

As illustrated here, a short straddle realizes maximum profit when the stock price is trading exactly at the short strike at expiration. Because of this, achieving maximum profit on a short straddle is very unlikely

However, since a short straddle collects the most extrinsic value compared to any other option selling strategy, taking partial profits on a short straddle can lead to more profits than making maximum profit on other less aggressive strategies.

The sections below explain the why behind the profit/loss levels at various stock prices at the time of expiration:

Stock Price Below the Lower Breakeven Price (\$219.70):

The 250 call expires worthless but the short 250 put has more intrinsic value than the entire straddle was sold for (\$30.30), and therefore the straddle seller realizes a loss.

Stock Price Between the Lower Breakeven and the Short 250 Put (\$219.70 to \$250):

The 250 put has intrinsic value, but not more than the premium the trader collected when selling the straddle. The 250 call expires worthless. Consequently, the short straddle position is profitable.

Stock Price Between the Short Call Strike and the Upper Breakeven (\$250 to \$280.30):

The 250 call has intrinsic value, but not more than the premium the trader collected when selling the straddle. The 250 put expires worthless. Consequently, the short straddle position is profitable.

Stock Price Above the Upper Breakeven (\$280):

The 250 put expires worthless but the 250 call has more intrinsic value than the straddle was sold for, and therefore the short straddle position is not profitable. Since the stock price can rise indefinitely, the short call (and consequently the entire short straddle) has unlimited loss potential.

Great job! You’ve learned the general characteristics of the short straddle strategy. Now, let’s go through some visual trade examples to show you how selling straddles really works.

To visualize the performance of straddles relative to the stock price, let’s look at a few examples of real straddles that recently traded. Note that we don’t specify the underlying, since the same concepts apply to short straddles on any stock. Additionally, each example demonstrates the performance of a single straddle positionWhen trading more contracts, the profits and losses in each case will be magnified by the number of straddles traded.

Let’s do it!

The first example we’ll look at is a situation where the stock price trades in a tight range after an at-the-money straddle is sold, resulting in plenty of profits.

Here are the trade entry details:

Initial Stock Price: \$210.72

Initial Implied Volatility: 15%

Strikes and Expiration: 211 put and 211 call expiring in 77 days

Straddle Sale Price: \$5.46 for the put and \$4.32 for the call = \$9.78 total credit

Breakeven Prices: \$201.22 and \$220.78 (\$211 – \$9.78 and \$211 + \$9.78)

Maximum Profit Potential: \$9.78 net credit x 100 = \$978

Maximum Loss Potential: Unlimited

Let’s visualize what happens that allows this trade to profit!

As you can see, selling straddles can be highly profitable when the stock price doesn’t rise or fall quickly with magnitude. In this case, the stock price traded near the short strike the entire time, leading to profits from time decay. Implied volatility remained near 15% the entire period, so a change in implied volatility really wasn’t a factor here.

In this example, the straddle price continously fell, presenting many opportunities for the short straddle trader to close the position early for profits. To lock in the profits or losses on a short straddle position, the short options can be simultaneously bought back at their current prices. For example, if the trader in this position bought back the straddle for \$5.00, they would have locked in \$478 in profits: (\$9.78 initial sale price – \$5.00 closing price) x 100 = +\$478.

At expiration, the stock price was above \$211, which means the short call was in-the-money and the short put was out-of-the-money. However, the short 211 call only had \$1.50 of intrinsic value at expiration, which results in a \$828 profit for the straddle seller: (\$9.78 sale price – \$1.50 expiration value) x 100 = +\$828.

## Trade Example #2: Large Loss

In the next example, we’ll look at how a short straddle performs when the stock price falls significantly. In particular, we’ll examine a short straddle on a stock in late 2008.

Initial Stock Price: \$126.20

Initial Implied Volatility: 23%

Strikes and Expiration: 126 put and 126 call expiring in 78 days

Straddle Sale Price: \$5.18 for the put and \$5.07 for the call = \$10.25 total credit

Breakeven Prices: \$115.75 and \$136.25 (\$126 – \$10.25 and \$126 + \$10.25)

Maximum Profit Potential: \$10.25 net credit x 100 = \$1,025

Maximum Loss Potential: Unlimited

Let’s visualize what goes wrong, causing the trade to lose money:

As you can see here, the short straddle position did ok in the first 40 days of the period. However, the stock price suddenly collapsed from \$125 to \$95. At the same time, implied volatility in the expiration cycle of the short straddle spiked to over 75%. Consequently, the price of the 126 straddle surged in price to \$35. With an initial sale price near \$10, the loss is \$2,500 per short straddle when the straddle is worth \$35.

If the trader wanted to take losses before expiration, the straddle can be bought back at its current price. For example, if the straddle was bought back for \$25, the trader would have locked in \$1,475 in losses: (\$10.25 initial sale price – \$25 closing price) x 100 = -\$1,475.

At expiration, the stock price was \$31 below the straddle’s strike price of \$126, which translates to \$31 of intrinsic value for the 126 put and \$0 of intrinsic value for the 126 call. Because of this, the expiration loss for the straddle seller is \$2,075: (\$10.25 initial sale price – \$31 final straddle value) x 100 = -\$2,075.

## Changes in a Short Straddle's Delta/Directional Exposure

In addition to demonstrating the potential losses from selling straddles, this example serves as an excellent demonstration of how a straddle’s position delta can change rather quickly.

As mentioned earlier, a short straddle position has negative gamma, which means that as the stock price trends in one direction, the delta (directional risk) of the position will grow in the opposite direction.

For example, if the stock price increases, the delta of a short straddle position will become more negative, resulting in a bearish position. Conversely, when the stock price decreases, the delta of a short straddle position will grow more positive, resulting in a bullish position.

Let’s visualize the concept of negative gamma using the same example as above:

As visualized here, the position delta of the short straddle moves inversely with the stock price. When the stock price increases, the position delta becomes more negative, which means the position is more bearish. When the stock price decreases, the position delta becomes more positive, which means the position is more bullish. Intuitively, this should make sense because the maximum profit potential of a short straddle occurs when the stock price is right at the strike price.

Therefore:

When the stock price falls below the strike price, the position becomes bullish because the ideal scenario is for the stock price to rise back up to the strike price.

When the stock price rises above the strike price, the position becomes bearish because the best case scenario is for the stock price to fall back down to the strike price.

In the final example, we’ll look at a scenario where a short straddle trader doesn’t make or lose much money, which occurs when the stock price is near one of the straddle’s breakeven prices at expiration.

Initial Stock Price: \$210.56

Strikes and Expiration: 211 put and 211 call expiring in 60 days

Straddle Sale Price: \$4.83 for the put and \$3.51 for the call = \$8.34 total credit

Breakeven Prices: \$202.66 and \$219.34 (\$211 – \$8.34 and \$211 + \$8.34)

Maximum Profit Potential: \$8.34 net credit x 100 = \$834

Maximum Loss Potential: Unlimited

Let’s see what happens that causes the trade to break even:

As we can see here, the stock price fell significantly after the short straddle was entered. As a result, the position had losses over the entire period. At the worst point, the loss on the short straddle was nearly \$1,700.

Fortunately, the stock price rallied back to the short straddle’s lower breakeven price. At expiration, the 211 put had slightly less than \$8.34 of intrinsic value, which means the position squeaked out a tiny profit because the initial straddle sale price was \$8.34.

Regarding a share assignment, the short 211 put is in-the-money at expiration, which means the trader would be assigned +100 shares of stock if the put was held through expiration (if not already assigned shares early).

## Final Word

Let’s briefly review a few of the key concepts we have learned:

• When the stock prices breaks one of the strike prices sold, the straddle can experience significant losses.
• In the straddle, the most you can ever make is the credit received.
• Short straddles have a negative gamma, which has an inverse relationship with delta.

Curious how the strangle compares to the straddle? Check out our article here, Straddles vs Strangles.

## Short Strangle Explained – The Ultimate Visual Guide

The short strangle is an options strategy that consists of selling an out-of-the-money call option and an out-of-the-money put option in the same expiration cycle.

Since selling a call is a bearish strategy and selling a put is a bullish strategy, combining the two into a short strangle results in a directionally neutral position.

However, if the stock price moves towards one of the short strikes, the trade becomes directional and can suffer significant losses. When selling strangles, profits come from the passage of time or decreases in implied volatility, as long as large stock price movements in one direction do not occur.

TAKEAWAYS

• The short strangle is best suited for neutral, or “sideways” market direction.

• One short call and one short put comprise this strategy.

• The loss on this strategy is infinite  because of the short call sold.

• Total profit is limited to the credit received.

## Short Strangle Strategy Characteristics

Before getting into examples, let’s look at the short strangle’s general characteristics:

➥Max Profit Potential: Total Credit Received x 100

➥Max Loss Potential: Unlimited

➥Expiration Breakevens:

Upper Breakeven = Call Strike Price + Total Credit Received

Lower Breakeven = Put Strike Price – Total Credit Received

➥Estimated Probability of Profit: Between 50-99% depending on the options sold. However, the higher the probability of profit, the lower the potential reward.

To demonstrate these characteristics in action, let’s take a look at a basic example and visualize the position’s potential profits and losses at expiration.

## Expiration Profit/Loss Potential

In the following example, we’ll construct a short strangle position using the following option chain:

In this case, we’ll sell the 190 put and the 210 call. Let’s also assume the stock price is trading for \$200 when the strangle is sold.

Initial Stock Price: \$200

Short Strikes Used: 190 put, 210 call

190 Put Sale Price: \$3.78

210 Call Sale Price: \$4.31

Total Credit Received: \$3.78 + \$4.31 = \$8.09

The following visual describes the potential profits and losses at expiration when selling this particular strangle:

### Short Strangle Chart

As illustrated here, a short strangle realizes the maximum profit potential when the stock price is between the short strikes at expiration because each option expires worthless. Additionally, the collection of premium extends the breakeven prices beyond the short strikes of the trade, which means the stock price can trade beyond one of the short strikes and the position can still be profitable.

More specifically, the strangle will be profitable at expiration as long as one of the options isn’t in-the-money by more than the total credit received from selling the strangle.

To visualize the performance of strangles relative to the stock price, let’s look at a few examples of real strangles that recently traded. Note that we don’t specify the underlying, since the same concepts apply to short strangles on any stock. Additionally, each example demonstrates the performance of a single strangle position.

When trading more contracts, the profits and losses in each case will be magnified by the number of strangles traded.

## Trade Example #1: Maximum Profit Strangle

The first example we’ll look at is a situation where a hypothetical trader sells a strangle with a call and put that have deltas near ±0.20.

With a delta near ±0.20, the call and put both have an estimated 20% probability of expiring in-the-money, respectively. Because of this, the strangle as a whole has an approximate 40% probability of expiring in-the-money, which translates to a 60% probability of expiring out-of-the-money.

Initial Stock Price: \$212.44

Initial Implied Volatility: 14%

Strikes and Expiration: 201 put and 219 call expiring in 63 days

Strangle Sale Price: \$1.75 for the put and \$0.83 for the call = \$2.58 total credit

Breakeven Prices: \$198.42 and \$221.58 (\$201 – \$2.58 and \$219 + \$2.58)

Maximum Profit Potential: \$2.58 net credit x 100 = \$258

Maximum Loss Potential: Unlimited

Let’s examine this historical trade’s performance:

As you can see, selling strangles is profitable as long as the stock price doesn’t rise or fall significantly. In this case, the stock price was between the short strikes the entire time, leading to profits from time decay. The options decrease in price as time passes because there is a diminishing probability that each option will expire in-the-money.

In other words, when the stock price remains between the short strikes, the probability that the call or put expire in-the-money decreases as time passes, which explains the strangles decaying price.

At around 18 days to expiration, you’ll notice that the strangle’s price rises from \$0.50 to \$2.00. The strangle’s price increase can be explained by the sharp stock price decrease and the subsequent increase in implied volatility to 21% (not visualized in the chart). However, the short strangle position was still profitable because the profits from time decay at that point were greater than the losses from the movements in the stock price and implied volatility.

In this example, the strangle price was below the initial sale price the entire period. As a result, the trader had ample opportunity to close the position before expiration to lock in profits. To close a short strangle, the short options need to be bought back at their current prices. For example, if the strangle trader bought back the strangle for a \$1.00 debit, they would have locked in profits of \$158: (\$2.58 initial sale price – \$1.00 closing price) x 100 = +\$158.

With the stock price between the short strikes at expiration, the 201 put and 219 call expired worthless, resulting in the maximum profit potential of \$258 for the strangle seller.

The example above demonstrates what can go right when selling strangles. In the next demonstration, we’ll look at a scenario where a short strangle position turns into a big loser.

## Trade Example #2: Significant Loss

In the last example, you saw how a sharp decrease in the stock price towards the short put strike could lead to an increase in the price of the strangle. In this example, we’ll examine what happens to the price of a strangle when the stock price collapses through the short put strike. Additionally, we’ll investigate how the position’s directional exposure (delta) changes.

Initial Stock Price: \$524

Initial Implied Volatility: 26%

Strikes and Expiration: 495 put and 555 call expiring in 39 days

Strangle Sale Price: \$6.35 for the put and \$6.20 for the call = \$12.55 total credit

Breakeven Prices: \$482.45 and \$567.55 (\$495 – \$12.55 and \$555 + \$12.55)

Maximum Profit Potential: \$12.55 net credit x 100 = \$1,255

Maximum Loss Potential: Unlimited

As you can see here, the short strangle position did not experience continuous profits like the previous example. Between 32 and 24 days to expiration, the stock price collapsed from nearly \$540 to \$460, which is \$35 below the short put’s strike price of \$495. At the same time, implied volatility increased from 26% to 54%. As a result of the directional move and shift in implied volatility, the price of the put surged to \$42 while the call price fell to \$2. Because of this, with 25 days to expiration, the short strangle trader has the following profits and losses on each option:

➜ Short Call Profit: (\$6.20 sale price – \$2.00 current price) x 100 = \$420

➜ Short Put Loss: (\$6.35 sale price – \$42.00 current price) x 100 = -\$3,565

​Net Loss: \$420 profit – \$3,465 loss = -\$3,145

When the stock price collapses through the short put strike before expiration, the loss on the short put will likely be greater than the profit on the short call, resulting in a net loss for a strangle seller.

On the other hand, when the stock price increases through the short call strike before expiration, the loss on the short call will likely be greater than the profit on the short put, which also results in a net loss for the short strangle trader.

Fortunately, in this example, the stock price regained its losses and was between the short strikes at expiration, leading to the maximum profit of \$1,255 for the strangle seller.

As mentioned previously, the strangle trader in this example could have closed the position early to lock in losses. For example, if the trader wanted to cut the losses when the strangle traded up to \$30, they could have bought back the strangle for \$30 and locked in losses of \$1,745: (\$12.55 initial sale price – \$30 closing price) x 100 = -\$1,745.

## Negative Gamma Demonstration

In addition to demonstrating the potential losses from selling strangles, the example below serves as a great demonstration of how a strangle’s directional risk can change rather quickly. A short strangle position has negative gamma, which means that as the stock price trends in one direction, the position delta (directional exposure) of the position will grow in the opposite direction.

For example, if the stock price increases, the delta of a short strangle position will become more negative, resulting in a bearish position. Conversely, when the stock price decreases, the delta of a short strangle position will grow more positive, resulting in a bullish position.

Let’s visualize the concept of negative gamma using the same example as above:

## Short Strangle and Delta

As visualized here, the position delta of the short strangle moves inversely with the stock price. When the stock price increases, the position delta becomes more negative. When the stock price decreases, the position delta becomes more positive. Therefore, when trading neutral trading strategies, understand that the positions can become very directional in a short period of time.

In this example, the position delta started near zero because a +0.20 delta call and -0.20 delta put were sold (respective position deltas of -20 and +20). However, when the stock price collapsed, the put delta approached -1 while the call delta approached zero. As a result, the position delta grew positively because being short a negative delta option (a put) results in a positive position delta.

In the case of this 495/555 strangle, the position delta increased from -20 to +70 when the stock price fell from \$540 to \$460. With a position delta of -20, the short strangle has the directional exposure of being short 20 shares of stock. On the other hand, with a position delta of +70, the short strangle has the directional exposure of being long 70 shares of stock.

The moral of the story is that a short strangle is not likely to remain directionally neutral when the stock price changes. Because of this, the delta of a short strangle should be monitored closely, especially near expiration.

## Trade Example #3: Partially Profitable Short Strangle

In the final example, we’ll look at a scenario where a short strangle trader only makes a partial profit at expiration. Partial profits occur when the stock price is between one of the short strikes and the breakeven price on that side. Here’s the setup:

Initial Stock Price: \$108.29

Strikes and Expiration: 103 put and 111 call expiring in 44 days

Strangle Sale Price: \$1.40 for the put and \$1.82 for the call = \$3.22 total credit

Breakeven Prices: \$99.78 and \$114.22 (\$103 – \$3.22 and \$111 + \$3.22)

Maximum Profit Potential: \$3.22 net credit x 100 = \$322

Maximum Loss Potential: Unlimited

Let’s see what happens!

As we can see here, the stock price fell below the short put strike shortly after the trade was entered, and remained below the put for most of the period. Consequently, this short strangle did not do particularly well, and was worth almost twice the entry credit at one point. However, the position was partially profitable at expiration because the stock price was above the lower breakeven price.

With the stock price at \$101.50 at expiration, the 103 put expired worth \$1.50, resulting in a profit of \$172: (\$3.22 initial sale price – \$1.50 strangle price at expiration) x 100 = +\$172.

Regarding a share assignment, the 103 short put would expire to +100 shares of stock if held through expiration. To avoid a share assignment, the put would need to be bought back before expiration. However, it’s always possible that the trader is assigned early on the in-the-money short put before expiration.

## Final Word

Let’s briefly review a few of the key concepts we have learned:

• When the stock prices breaks one of the strike prices sold, the strangle can experience significant losses.
• In the strangle, the most you can ever make is the credit received.
• Short strangles have a negative gamma, which has an inverse relationship with delta.

## Synthetic Long Stock & Synthetic Short Stock W/ Visuals

▼ The synthetic short stock options strategy consists of simultaneously selling a call option and buying the same number of put options at the same strike price.

Both options must be in the same expiration cycle. As the strategy’s name suggests, a synthetic short stock position replicates shorting 100 shares of stock.

▲ The synthetic long stock position consists of simultaneously buying a call option and selling the same number of put options at the same strike price. Both options must be in the same expiration cycle. As the strategy’s name suggests, a synthetic long stock position replicates buying and holding 100 shares of stock.

By owning a call option and selling a put option at the same strike price, the synthetic long position’s delta exposure will be +100. Compared to buying shares of stock, a trader may be able to enter a synthetic long stock position with a lower margin requirement than buying shares.

TAKEAWAYS

• The profit/loss profile of a “synthetic short” mirrors that of short stock and is thus bearish.

• The strategy consists of 1.) short call and 2.) long put.

• Because of the short call, risk on this strategy is unlimited.

• Max profit occurs on the long put side, and happens if the stock goes to zero.

• Because of options leverage, the synthetic short options strategy can be a cheaper alternative than shorting stock.

• The position is created from buying a call option and selling a put option of the same strike.

• The position is suited for very bullish investors who don’t want to pay for the stock.

• Due to the short putmax loss in this strategy is great.

## Synthetic Short Stock Strategy Characteristics

Let’s go over the synthetic short stock strategy general characteristics:

Max Profit Potential

If the synthetic is entered for a debit: (Strike Price – Debit) x 100

If the synthetic is entered for a credit: (Strike Price + Credit) x 100

Max Loss Potential: Unlimited

Expiration Breakeven

If the synthetic is entered for a debit: Strike Price – Debit Paid

If the synthetic is entered for a credit: Strike Price + Credit Received

To demonstrate these characteristics in action, let’s take a look at a basic example.

## Profit/Loss Potential at Expiration

In the following example, we’ll replicate a short share position from the following call and put options:

In this example, we’ll simultaneously sell the 100 call and buy the 100 put. When trading synthetic stock positions, you can use any strike price, as long as you purchase the put and sell the call at that strike (in the same expiration cycle).

We choose to use the at-the-money options because they are the most actively traded options, which benefits traders in terms of liquidity.

Lastly, let’s assume the stock price is trading for \$100 when entering the position:

Initial Stock Price: \$100

Synthetic Short Stock Setup: Short 100 call for \$3.53; Long 100 put for \$3.44

Breakeven Price: \$100 strike price + \$0.09 credit received = \$100.09

As you can see, the position’s breakeven is only \$0.09 above the current stock price. The difference is explained by carrying costs that are priced into the options. In this example, the carrying costs stem from the risk-free interest rate, as the stock in this example does not pay any dividends.

The following visual describes the position’s potential profits and losses at expiration:

### Synthetic Short Chart

As we can see here, the risk profile of a synthetic short stock position is identical to an actual short stock position. The only difference is the breakeven price, which is miniscule. To be profitable when trading synthetic short stock positions, the stock price must decrease from the point of entry.

Great job! You’ve learned the general characteristics of the synthetic short stock position. Now, let’s go through a real trade example and visualize the performance of the position through time.

## Synthetic Short Stock Trade Example

To bring the previous section to life, we’re going to look at a real synthetic short stock example and visualize the position’s performance over time.

Initial Stock Price: \$109.82

Strikes and Expiration: Short 110 call for \$4.13; Long 110 put for \$4.28; Both options expiring in 45 days

Net Debit: \$4.28 in premium paid – \$4.13 in premium collected = \$0.15 net debit

Breakeven Price: \$110 strike price – \$0.15 net debit = \$109.85

Maximum Profit Potential: \$109.85 x 100 = \$10,985 (stock price at \$0)

Maximum Loss Potential: Unlimited

Let’s see what happens!

As you can see, the performance of a short stock position and synthetic short stock position are identical. When the stock price increases from the point of entry, both positions have losses. Conversely, when the stock price falls below the entry price, both positions are profitable.

Now that we’ve learned the synthetic short strategy, let’s move on to the synthetic long options strategy!

## Synthetic Long Stock - Strategy Characteristics

Let’s go over the synthetic long stock strategy’s general characteristics:

➦ Max Profit Potential: Unlimited

➦ Max Loss Potential:

If the synthetic is entered for a debit: (Strike Price + Debit) x 100

If the synthetic is entered for a credit: (Strike Price – Credit) x 100

➦ Expiration Breakeven:

If the synthetic is entered for a debit: Strike Price + Debit Paid

If the synthetic is entered for a credit: Strike Price – Credit Received

➦ Estimated Probability of Profit: Approximately 50% because a synthetic long stock replicates owning shares of stock.

To demonstrate these characteristics in action, let’s take a look at a basic example.

## Profit/Loss Potential at Expiration

In the following example, we’ll replicate a long share position from the following option chain:

In this example, we’ll simultaneously buy the 100 call and sell the 100 put. When trading synthetic stock positions, you can use any strike price because the breakeven of each position will be the same. We choose to use the at-the-money options because they are the most actively traded options, which benefits traders in terms of liquidity. Lastly, let’s assume the stock price is trading for \$100 when entering the position:

Initial Stock Price: \$100

Synthetic Long Stock Setup: Long 100 call for \$3.53; Short 100 put for \$3.44

Debit Paid for Synthetic: \$3.53 paid – \$3.44 collected = \$0.09

Breakeven Price\$100 strike price + \$0.09 debit paid = \$100.09

As you can see, the position’s breakeven is only \$0.09 above the current stock price. The difference is explained by carrying costs that are priced into the options. In this example, the carrying costs stem from the risk-free interest rate, as the stock in this example does not pay any dividends.

The following visual describes the position’s potential profits and losses at expiration:

As we can see here, the risk profile of a synthetic long stock position is identical to an actual long stock position. The only difference is the breakeven price, which is miniscule. To be profitable when trading synthetic long stock positions, the stock price must increase from the point of entry.

Nice job! You’ve learned the general characteristics of the synthetic long stock position. Now, let’s go through a real trade example and visualize the performance of the position through time.

## Synthetic Long Stock Trade Example

To bring the previous section to life, we’re going to look at a real synthetic long stock example and visualize the position’s performance over time. Here’s the trade setup:

Initial Stock Price: \$109.82

Strikes and Expiration: Long 110 call for \$4.13; Short 110 put for \$4.28; Both options expiring in 45 days

Net Credit: \$4.28 in premium collected – \$4.13 in premium paid = \$0.15 net credit

Breakeven Price: \$110 strike price – \$0.15 net credit = \$109.85

Maximum Profit Potential: Unlimited

Maximum Loss Potential: \$109.85 x 100 = \$10,985

Let’s see what happens!

As you can see, the performance of a long stock position and synthetic long stock position are identical. When the stock price increases from the point of entry, both positions are profitable. Conversely, when the stock price falls below the entry price, both positions have losses.

## Final Word

Hopefully, this short guide has helped you better understand synthetic options strategies! Let’s review what we have learned:

• The synthetic short stock strategy can be a cheaper alternative to selling a stock.
• Because of the short call, the synthetic short position has infinite risk.
• Be sure to choose liquid options when determining your strike price!

• The synthetic long stock strategy is referred to as “synthetic” because it mirrors a stock position of 100 shares.
• For small accounts wanting upside exposure, synthetic longs are a great alternative to buying more expensive stock.
• Because of the short, unhedged put, max loss is great for synthetic long positions.