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I’ve been trading futures for over a decade and have tried a number of different strategies. One thing I’ve learned is that this isn’t an easy game. It seems that there is always someone out there smarter than you. Out of all the strategies I’ve tried, I would estimate that selling option premium has offered the best percentage of winning trades. You will often hear that 90% of options expire worthless. I’m not sure where they come up with that figure, but I do know that most of the traders that I have seen buy premium have ended up losing some money. The traders that I have seen sell premium usually seem to experience more success.
I am going to talk about selling option premium, and specifically about the strategy called a Short Strangle. A short strangle is a position that comes about by simultaneously being short an out-of-the-money Call and Put in the same futures contract. I am going to go over two scenarios in the Soybean complex. I am using the Oilseed complex because this sector of the futures markets is poised, in my opinion, to provide plenty of employable scenarios options this summer. I trade the agricultural markets quite a bit, and strongly believe these markets are going to offer a few really good opportunities this season. |
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Presently, the November ’07 Soybean futures contract is trading around $9.40/bushel. A short strangle that looks interesting is the Selling the November Soybean $10.00 Call & $8.00 Put for a credit of about $2,000. The expiration date for November Soybean Options is October 20th. If November Soybeans settle at or between $8.00 and $10.00 per bushel, you will be able to realize gross profits equal to all the premium you received when you sold the Strangle. The expectation for this strategy to work would be that volatility decreases.
If you cannot view the above chart, go here.
When November Soybeans move higher your short $10.00 Calls will gain value and your $8.00 Puts will lose value. It’s a wash, right? Not really. Over time the calls and puts will lose extrinsic value due to time decay, so you will have time decay working for you. Your breakeven is at $7.60/bushel or $10.40/bushel at expiration, so absent a margin call liquidation, this position permits a fairly wide $2.80/bushel fluctuation in prices where it can still offer the opportunity to work. That said, if you get a market that rallies or breaks far and fast, this strategy will most likely lose money. You also don’t have to hold this trade till expiration. Let’s say a month has
gone by and November Soybeans are trading at $9.42. We are in between our strike prices and the Calls have gained 2 cents and your put options have lost 12 cents from your entry. You are currently up 10 cents or $500 per Strangle sold. You may now buy the $10.00/$8.00 Strangle back and pocket a gross profit of $500 per Strangle. |
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I am now going to talk about legging into a short Strangle. This Strategy is more aggressive and will have a better reward if you are correct in your original speculation. The November Soybeans have rallied a $1.00/bushel in the last three weeks. This is a relatively large move in a short amount of time. You believe Soybeans are overbought and due for a correction. The November Soybean $10.00/call is trading around $1,500, so you sell this Call option. The plan is to sit on this short call option and sell a November Soybean Put option if we get a break in price. When you sold the 1000/call, the 800/put was trading at $500. Let’s say a week or two goes by and November Soybeans have
broke 60 cents and are trading at $8.80/bushel. You then sell the November Soybean $8.00/put for approximately $1,500. With this more risky approach, you have been fortunate enough to beat the odds and time the market movements rather well, and you now have a short strangle that, if it works to expiration, will now gross a credit of $3,000 per strangle instead of $2,000, like first example. This sounds better, right? What if you are wrong in your original speculation and prices rally 40 cents, instead of breaking 40 cents? You will be behind the eight ball and have to make a decision. I am going to list 3 scenarios:
- Do you ride out the Call option and hope we see some weakness and sell a Put option on a break in prices?
- Do you just hold the short call option and monitor Soybean prices and hope November Soybeans settle below $10.00/bushel at expiration and keep the premium you received?
- Do you sell a Put option and leg into the short Strangle at a worse price than you would have originally received?
Keep in mind that if you sell naked Calls and/or Puts you have unlimited risk and limited potential. I would suggest you set a risk tolerance. What are you willing to lose if this trade goes awry? I would never go into any trade without knowing the approximate risk:reward and have a disciplined trading plan set for both worst-case and best-case scenarios.
The Short Strangle is but one of a number of viable options strategies for those who have the risk tolerance, capital, and trading discipline to speculate in futures options. The volatility in the grain markets has helped to pump up the premium in the options in those markets. This should certainly be looked at as an opportunity for those who can take the time to understand options or work with someone like myself who can guide traders through the trading approach. |
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About the Author
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Since his arrival in Futures and Options in 1995, John Garrity has served as an equity raiser, currency analyst, and has trained hundreds of clients in the art of trading. Mr. Garrity provides all of his clients with a fundamental and technical analysis on various markets by writing a daily Garrity Report that is e-mailed twice each trading day. Mr. Garrity comes from a family with over 30 years of experience in the agricultural markets. His Father trades at the Chicago Mercantile Exchange in the Meats. |
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