Short Straddles vs. Strangles Options Strategies

Short straddles and strangles are neutral options strategies, meaning they profit from minimal price movement in the underlying asset. They are also considered directionally agnostic strategies, meaning they don't require the trader to try to predict the direction of price movement in the underlying position, only that it will remain within a certain range. 

Both short straddles and strangles are credit trades. Traders receive a premium (minus any transaction fees) to enter the position. 

To execute a short straddle, a trader sells a call and a put on the same underlying asset with the same expiration date and the same strike prices (typically at the money). To execute a short strangle, a trader sells a call and put on the same underlying security with the same expiration date but different strike prices (both out of the money). 

The maximum profit for both strategies—realized if the options expire worthless—is equal to the credit received when options are sold minus any transaction fees. To earn the maximum profit for a short straddle, the underlying must be exactly at the strike price at expiration. To earn the maximum profit for a short strangle, the underlying must be between the two strike prices when the options expire. 

Both short straddles and strangles have two break-even points, excluding transaction fees. For the short straddle, the upper break-even point is equal to the strike price plus the total credit received, and the lower break-even point is equal to the strike price minus the total credit received. For a short strangle, the upper break-even point is equal to the call strike price plus the total credit received, while the lower break-even point is equal to the put strike price minus the total credit received. 

The images below illustrate the risk and reward possibilities of short straddles and strangles at expiration. 

Traders generally use short straddles or strangles when they expect the underlying to remain within a well-defined range, or when they're forecasting a drop in implied volatility (IV)—a measure of the market's expectation of future volatility in the underlying asset. 

For example, a trader might expect a stable, blue-chip stock to remain range-bound during a calm period in the broader market. Or—after an earnings report or merger announcement—a trader might anticipate a significant drop in IV that comes without a substantial move in the underlying position. 

Option traders might also use short straddles and strangles to benefit from theta decay (the decrease in the value of an option over time). As time passes, the options sold in these strategies lose value, making them cheaper to buy back if a trader closes their position prior to expiration. 

Both short straddles and strangles can offer traders a way to potentially profit from range-bound price action, elevated options premiums, or a sharp decline in IV following a known event, but they come with significant risk. 

Short straddles and strangles are undefined risk strategies, meaning unlimited losses are possible. 

On the call leg of these trades, the maximum potential loss is theoretically unlimited. If the underlying asset's price moves above the short call strike, it's likely to be assigned at expiration, requiring the trader to sell the underlying. This transaction—assuming the trader doesn't already own shares of the underlying—would leave them with an undesired short position against the asset, which (again, theoretically) can rise indefinitely. To avoid this scenario, the straddle or strangle trader would want to close (purchase) the short call before expiration. 

On the put leg of both short straddles and strangles, the maximum loss—if the underlying moves below the short put strike—is equal to the strike price of the put option minus the total premium received. 

Traders should be aware of the greater risk potential associated with undefined risk strategies like short straddles and strangles. And there are several other key risks to consider: 

• Early assignment risk (when American-style options settlement applies). If the underlying asset moves in the money (ITM) on either leg before expiration, the trader could be assigned, leaving them with an undesired short or long position.
• Capital requirements. These strategies often require substantial capital to cover potential losses because of the undefined risk involved.
• Illiquidity. A lack of liquidity can make it challenging to enter and exit positions at desired prices.
• Unexpected market events. Company guidance revisions, economic news, or other unexpected market events can lead to larger-than-anticipated price movements in the underlying position, putting traders at a greater risk of incurring losses.
• Outsized market moves. Even without an unexpected market event, traders are subject to the risk of continued movement in the underlying position.
• Pin risk. If the underlying position closes at or very close to the strike price of the option, it can become unclear whether or not the option will be exercised. This creates the possibility of being assigned on one leg of the trade, leaving the trader with an undesired long or short position. This risk is particularly salient on Fridays, when many options expire, and there's a risk the underlying could move substantially by the time the market opens on Monday. 

Determining whether to opt for a short straddle or strangle strategy depends on a trader's goals and risk tolerance. But there are several other key factors to consider. 

The expected magnitude of price movement in the underlying position is one of the primary considerations. If a trader expects very little to no movement in the underlying, a short straddle typically offers higher premiums—at the cost of greater risk potential. However, if a trader expects some movement, but not too much, a short strangle provides wider break-even points and lower risk potential in exchange for lower premiums. 

Liquidity is worth considering as well. Illiquid options aren't ideal for short straddles and strangles. But illiquidity is usually riskier for short straddles than short strangles. If the underlying security moves sharply, exiting a short straddle—which is typically executed at the money—can be more difficult or slower. In a short strangle, wider break-even points offer more of a price buffer for traders to exit the trade before losses mount. 

Margin requirements are another factor traders should keep in mind. Short straddles often have a larger impact on buying power (and therefore higher margin requirements) because they are typically at-the-money trades that have greater initial risk than short strangles. 

Finally, traders should always examine an underlying asset's IV percentile. This is the current IV of the underlying compared to its IV over a specified period, usually the past 52 weeks. 

Recall that higher IV acts like a rising tide on options prices, lifting all boats (both call and put options prices). As a result, an underlying's IV percentile can influence a trader's decision to opt for a short strangle versus a short straddle. If IV is higher than usual (suggested by a higher IV percentile), a short strangle may offer sufficient premiums for traders to choose that strategy instead of the riskier short straddle option. 

The expected absolute move in the underlying based on its IV can be a useful tool for traders looking to execute short straddles or strangles. It's available on the thinkorswim^® platform under the Trade tab > Option Chain. 

Given the option chain in the table below, a trader could implement a short straddle strategy by selling a 100-strike put for $1.40 and a 100-strike call for $1.40 for a total credit of $2.80 (minus transaction fees). At expiration, not including transaction fees, if the underlying stock is within a range of $97.20 and $102.80, the trade would be profitable. 

To execute a short strangle, a trader could sell a 98-strike put for $0.85 and a 102-strike call for $0.80, receiving a $1.65 net credit (minus transaction fees). Although the credit would be lower here, the underlying stock could move more before this trade would become unprofitable. At expiration, not including transaction fees, this trade would be profitable if the stock remained between $96.35 and $103.65. 

Trading short straddles and strangles around earnings can be a risky proposition, but it also might have benefits for shrewd traders. 

IV tends to rise prior to earnings announcements as traders anticipate potentially significant stock price movements. This causes options premiums to rise, meaning short straddles and strangles can offer higher premiums prior to earnings. 

After a company releases its earnings report, the uncertainty surrounding the company's stock performance tends to decline, which can cause IV to drop sharply. Traders call this drop an "IV crush."  

Both call and put option prices decline in the wake of an IV crush, allowing a trader using a short straddle or strangle strategy to buy back the options they sold at lower prices if they wish to exit the trade prior to expiration. 

However, a post-earnings drop in IV is only beneficial for short straddles and strangles if the price of the underlying position doesn't move substantially due to new information provided to the market in the earnings release. If the underlying moves substantially, it can breach one of the break-even points, leading to losses. 

Short straddles and strangles can be used to profit from range-bound price movement, falling IV, and/or theta decay, but these strategies come with undefined risk. 

For traders who are looking for (theoretically) unlimited profit potential and defined risk, long straddles and long strangles—which, conversely, take advantage of rising IV and significant movement in an underlying security—could be a better choice. 

Traders who want to take advantage of the typical factors that make short straddles and strangles profitable but aren't comfortable with undefined risk might consider short iron condors. Short iron condors add two protective "wings" (a long out-of-the-money call and put), enabling traders to ensure there is a theoretical maximum loss on their trade—unless pin risk becomes a factor. 

Short straddles and strangles can be an effective way to potentially earn income in a portfolio during periods of sideways trading, but it's important to understand and be comfortable with the risks involved before implementing these more advanced strategies.