Options Corner
WWhat you have done is taken in total premium of 95 pts (multiplied by whatever size you are comfortable with; for example, if £10 per point then you would take in £950 of premium). If the FTSE does not break through either 5000 or 6000 at the point of expiry, then you will keep the 95 pts. Of course, as we move closer to expiry then the premium would diminish (assuming the index does not break out of the range that is) and you would be free to purchase back the premium and take the profit at any time -you do not have to run it to expiry. My own personal rule of thumb when selling options is when 85-90% of the premium has been stripped out then I buy back — why hang around for the remaining 10-15% and take the risk of giving back your profits? In the example above, if the index did move out of the 2 strangle parameters, i.e. rise above 6000 or fall below 5000, then you would only begin to lose money at the respective strangle parameters plus the premium received on the call side and minus the premium received on the Put side, i.e. 6095 & 4905. Here is a P&L diagram of a Strangle strategy -
90 | www.financial-spread-betting.com | July 2012
There is one major factor you must be aware of when selling strangles or indeed straddles and that is the impact of volatility - a component that we have touched upon before in previous articles which is, at its heart, a measure of the expected volatility investors anticipate over the remaining period of an option’s life. Basically, as a seller of premium you want to be selling options when volatility is high as this increases the premium value of the option. If you sell an option when volatility is low, then, even though time decay will be working in your favour (i.e. reducing the premium value), if there is a sharp uptick in volatility then the price of the option will rise. It is important to be aware of this when implementing a strangle strategy. You are looking to ideally incept such a strategy when (a) the instrument is at the midpoint of your expected continuation range and (b) when volatility is quite elevated - certainly not when volatility is low.