Profiting From Short Strangles – Part 2 – Possible Adjustments
by Peter D - February 16th, 2009 6:43 am
Possible adjustments for short strangles, including passive adjustments at expiration and active adjustments prior to expiration, are examined in this section. Let’s also re-iterate the practical “Strangle a Spy” example from Part 1 to provide additional clarity to the concepts:
- For prices at the close of 1/9/2009, Sell SPY Feb 70 PUT (20% downside cushion with SPY at $89) and Sell SPY Feb 105 CALL (17% upside cushion) for $0.81 credit.
- The margin requirement was $8.9 ATM (At-The-Money), $24.2 for SPY at $105, or $18.4 if SPY drops to $70.
1- Passive Adjustments at Expiration
a) No adjustment: If SPY closes between the two short strikes, e.g. $70 and $105 on 2/20/2009, both the short PUT and short CALL expired worthless, the maximum profit is realized, and no adjustment is needed.
b) Rolling “horizontally”: If SPY closes below the PUT strike, the short PUT can be rolled horizontally to the same strike next month for a credit. We are betting that the market will eventually recover to above the short PUT strike so that we keep the premium of all short PUT sold. We can keep rolling horizontally very month as premium sellers. However, the margin requirement does increase when the stock goes lower due to the increased PUT value. Prudent money management to absorb the margin requirement is a must when using Short Strangle strategy.
Let’s look at December 2008 expiration example to see how much credit we would get when rolling horizontally. Since the stock price would be below the short PUT strike, we would look at ITM rolling to simulate the possible credit.
SPY closed at $88.19 on 12/19/2008, rolling:
- Dec 89 PUT to Jan’09 89 gives $3.60 credit (short PUT is 1% ITM)
- Dec 91 PUT to Jan’09 91 gives $2.58 credit (3% ITM)
- Dec 94 PUT to Jan’09 94 gives $1.50 credit (7% ITM)
- Dec 97 PUT to Jan’09 97 gives $0.78 credit (10% ITM)
The amount of credit is also dependent upon the volatility reading at the time. Note that all these rolling of the PUT and selling of additional short CALL would give more credit than the $0.81 credit from…
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