When one buys an option in the stock market there are only three things that can happen and two of them are bad for the buyer. It goes your way right away which is good. It goes against you, which is bad. Or it goes sideways and time decay eats away the premium paid, which is bad.
It’s the same selling an option but much better because the time decay is on the seller’s side. If the stock goes sideways, the seller keeps the premium on the option. In other words, if one buys an option, one has a 66% chance of losing money; if one sells the option, it’s a 66% chance of making money.
So, obviously, it’s best to be on the sell side…
Simple as that?
Not so fast, if one does this without owning the stock, it’s called being “naked”, being naked a call, naked a put. Being nakedly short both the call and the put is a naked short strangle.
The trouble is the margin requirement on those are often times so high one might as well be trading the stock, and requirement often varies from brokerage to brokerage. So let’s say one might have to put up as much as $20,000 on a day trade with the prospect of making a couple of hundred bucks. A lot of risk, it would seem, for not much return. And it’s a day trade so there’s not all that much time to have the stock go your way or sideways.
But day trading is the key to this strategy.
First off, short strangles on volatile stocks can be extremely risky. If the price of the stock gets over the call strike or below the put strike, and runs, the loss can be virtually astronomical.
Day trading eliminates the overnight risk, and that is saying a lot. News after the market close, or just plain irrational exuberance in a volatile stock, can absolutely slaughter a short trader in strangles.
In addition, risk can be further controlled during the day, when the trade can be monitored, by using a tight stop-loss to guard against big price movements.
Secondly, with this day trading strategy the same expensive cash margin is being used over and over again anew each day and it usually is a lower requirement day by day as the strangle moves to the Friday expiration each week. But let’s say it’s an average $20,000 margin requirement…for simplicity’s sake.
This is a strategy that can be used on the weekly options for a any prominent stock — TSLA, AAPL, NFLX SHOP, NFLX BA, NVDA — with decent options liquidity and worthwhile price swings. And it’s a strategy that can be used week in and week out without ever having to buy the stock itself.
So what’s the result?
Today a TSLA a short 575/555 strangle gained $600 per strangle for the day trade. Let’s say one averages $600 per day through the week, and keep in mind both side the trade can expire worthless on Friday’s giving a big win (Friday’s are the best day obviously), yielding a weekly return of $3000.
A steady gain of 15% for the week, based on the $20,000 margin requirement without ever owning the stock. Multiply that by 52 weeks on same margin and…aw, you do the math.
This is just an example of how a trade can go. Other day trades (obviously) can be greater or less.
On the chart below the green dots are the price of the strangle, the green horizontal line at 21.66 is the price of the entry, the red horizontal line at 23.66 is the stop-loss, a $200 risk per strangle shorted. The white flag on the right axis is the profit for the the day trade. It is a negative number because it is a short.
(Click on the chart for a larger view)