Covered Strangle Strategy: The Ultimate Trading Guide

Introduction:

The covered strangle strategy is an option trading strategy that entails buying a stock and simultaneously selling call and put options with different strike prices on that stock. The strike price of the put option is lower than the current stock price, while the strike price of the call option is greater than the current stock price.

The covered strangle strategy requires a modestly bullish forecast, because the maximum profit is realized if the stock price is at or above the strike price of the short call at expiration.

Requirements:

Companies that pays consistently dividends (Blue Chip Stocks)
Cash-Secured Puts (CSP)
Covered Calls
Diversified Stocks & ETFs
Risk-Management (Proper Position size)
DTE ~ 45 Days

Monthly Return goal:

Minimum monthly return of 1.0% to 1.5% on average

Possible Return:

Shares Appreciation
Dividend Income
Cash Secured (CSP) Put Income
Covered Call Income

Note: CSP can always be built first before being assigned, and covered strangle can be built once assigned.

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How to Start:

On January 1st, 2023, an investor purchases 100 shares of stock XYZ at $50 per share, for a total cost of $5,000.

At the same time, the investor sells a call option on XYZ with a strike price of $55, expiring on January 31st, 2023, for a premium of $1 per share.
The investor also sells a put option on XYZ with a strike price of $45, expiring on January 31st, 2023, for a premium of $0.50 per share.

Options Net Premium: Put Premium + Call Premium

The total premium received from selling the call and put options is $150 (100 x $1 + 100 x $0.50).
So the cost (Break-Even) price of the underlying stock and options is $5,000 – $150 = $4850.

Dividends:

On January 15th, 2023, the investor receives a dividend payment of 0.75 cents per share, or $0.75 x 100 = $75.

OTM Trade Outcome:

On January 31st, 2023, if the stock price of XYZ is between $45 and $55, the investor will earn a profit from the premium collected.

ITM Put Options:

If the stock price of XYZ is less than or equal to $45 (Put Strike), the investor will exercise the put option and sell the shares for $45, resulting in a loss of $500 (45-50) but since he received $50 from the put option, the overall loss would be $450.

OTM Call Options:

If the stock price of XYZ is greater than or equal to $55, the investor will exercise the call option and sell the shares for $55, resulting in a profit of $500 (55-50) and adding the two premium received (Put and Call Premium), the overall profit would be $500 + (($0.50 + $1.00)*/100) = $650.

The dividend payment of $75 ($0.75 per share) will be added to the profit/loss. The maximum total profit for this trade would be $725.

Maximum Risk:

Potential loss is substantial and leveraged if the stock price falls. Below the lower strike price at expiration, losses are $2.00 per share for each $1.00 decline in stock price, because both the long stock and the short put lose as the stock price declines. In this case, the Max Loss would be the case if the stock goes to zero and can be calculated as follows:

Shares Max Loss: (# shares – Dividends) * 100
Put Max Loss: (Put Strike – Premium) * # of contracts * 100
Call Premium: (Call Premium) * # contracts * 100

Total Max Loss:

Shares Max Loss + Put Max Loss + Call Premium = $9275

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Covered Strangle Payoff Diagram:

Blue: Total Strategy

Green: Put Option

Red: Call Option

Pink: Break-Even

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FAQ

Q: What is a Covered Strangle Strategy?

A: A Covered Strangle Strategy is an options trading strategy that involves simultaneously selling a covered call and a cash-secured put on the same underlying stock, with different strike prices.

Q: How does the Covered Strangle Strategy work?

A: The strategy aims to generate income from selling the options premiums while taking advantage of a range-bound market, where the stock price is expected to stay between the strike prices of the call and put options.

Q: What are the potential benefits of the Covered Strangle Strategy?

A: The strategy allows traders to generate income from both the call and put options, potentially acquire the underlying stock at a lower price, and participate in a range-bound market while managing risk.

Q: What are the risks associated with the Covered Strangle Strategy?

A: Risks include the potential for stock assignment, which could tie up capital, and the possibility of significant losses if the stock price moves sharply beyond the strike prices of the call and put options.

Q: Is the Covered Strangle Strategy suitable for all market conditions?

A: The strategy is most suitable for range-bound markets, where the stock price is expected to stay within a certain range. It may not perform well in trending or highly volatile markets.

What the strategy on youtube by clicking HERE:

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