From the October 01, 2011 issue of Futures Magazine • Subscribe!

Double your option premium, balance your risk

Enter the strangle

In some markets, a strategy known as a strangle can help pare the negative effects of short-term increases in an option’s value prior to expiration. A strangle is a strategy of selling both a put and a call at the same time. It is a go-to premium generator for many professional portfolios and likely has a place in yours, as well (see "Benefits of the strangle").

The put is sold far below the current price of the underlying futures and the call is sold far above the current price of the underlying futures. If the futures price is anywhere between the two strike prices at expiration, both options expire worthless and the trader keeps all premium collected as profit. Although strangles often can produce more premium for the seller than selling naked puts or calls, they also can be considered a more conservative strategy, as gains on one side of the strangle tend to offset losses on the other.

This "offsetting" effect allows a wider range of movement in the underlying contract without significantly affecting a trader’s equity. Meanwhile, time gradually erodes the value of both the put and the call. Strangles are best employed in non-trending markets but also can be put to work in some slower-trending markets.

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