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Covered Strangle Options Trading Strategy Explained

Published on Thursday, August 9, 2018 | Modified on Wednesday, June 5, 2019

Covered Strangle

Covered Strangle Options Strategy

Strategy LevelAdvance
Instruments TradedCall + Put + Underlying
Number of Positions3
Market ViewBullish
Risk ProfileLimited
Reward ProfileLimited
Breakeven Pointtwo break-even points

The covered strangle option strategy is a bullish strategy. The strategy is created by owning or buying a stock and selling an OTM Call and OTM Put. It is called covered strangle because the upside risk of the strangle is covered or minimized.

The strategy is perfect to use when you are prepared to sell the holding or bought shares at a higher price if the market moves up but would also is ready to buy more shares if the market moves downwards.

The profit and in this strategy is unlimited while the risk is only on the downside.

When to use Covered Strangle strategy?

A covered strangle strategy can be used when you are bullish on the market but also want to cover any downside risk. You are prepared to sell the shares on profit but are also willing to buy more shares in case the prices fall.

Example

Suppose shares of ABC company is currently trading at ₹ 200. You buy 100 shares of the company or are already holding it. You sell an OTM Call at the strike price of ₹ 210 at a premium of ₹ 10 per share and OTM Put at the strike price of ₹ 190 at ₹ 8 per share. The lot size is 50 shares.

Covered Strangle Strategy Example

Current Market Price of ABC stock

200

Option Lot Size

50

Strike Price of Call Option

210

Premium Received

10 X 50= ₹ 500

Strike Price of Put Option

190

Premium Received

8 X 50= ₹ 400

Break Even Point


Upper = Strike Price of Short Call + Net Premium Received


Lower = Strike Price of Short Put - Net Premium Received


Upper = 220


Lower = 182

Covered Strangle Payoff

Nifty Closing Price (CP)

Call Option Payoff

BEP=220

(BEP-CP) X 50

MAX PROFIT= ₹ 500

Put Option Payoff

BEP= 182

(CP-BEP) X 50

MAX PROFIT = ₹ 400

Net Payoff

150

500

-1600

-1100

160

500

-1100

-600

172

500

-500

0

180

500

-100

400

190

500

400

900

200

500

400

900

210

500

400

900

Covered Strangle Strategy Example

Market View - Bullish

The Strategy is perfect to apply when you're bullish on the market and expecting less volatility in the market.

Actions

Buy 100 shares + Sell OTM Call +Sell OTM Put

The covered strangle options strategy can be executed by buying 100 shares of a stock while simultaneously selling an OTM Put and Call of the same the stock and similar expiration date.

Breakeven Point

two break-even points

There are 2 break-even points in the covered strangle strategy. One is the Upper break even point which is the sum of strike price of the Call option and premium received while the other is the lower break-even point which is the difference strike price of short Put and premium received.

Risk Profile of Covered Strangle

Limited

The risk on this strategy is only on the downside when the price moves below the strike price of the Put option.

Reward Profile of Covered Strangle

Limited

The maximum profit on this strategy happens when the stock price is above the call price on expiry. The profit is the total of the gain from buying/selling stocks and net premium received on selling options.

Max Profit Scenario of Covered Strangle

You will earn the maximum profit when the price of the stock is above the Call option strike price on expiry. You will be assigned on the Call option, would be able to sell holding shares on profit while retaining the premiums received while selling the options.

Max Loss Scenario of Covered Strangle

The maximum loss would be when the stock price falls drastically and turns worthless. The premiums received while selling the options will compensate for some of the loss.

Advantage of Covered Strangle

  • As the strategy involves buying shares when prices fall, there is long-term gain even if their short-term loss.
  • There is no upside risk due to the long position in stocks.
  • Allows you to earn income in a moderately bullish market.

Disadvantage of Covered Strangle

  • The substantial risk when the price moves downwards.
  • Risk of assignments.

How to exit?

  1. On expiry, retain the premiums and buy the shares in case the stock closes below Put strike prices.
  2. On expiry, retain the premiums, get the assignment of shares, sell the holding shares in case the stock closes above Put strike prices.

Simillar Strategies

Long Strangle, Short Strangle

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