Rolling The Untested Side In Short Strangles: Demystifying The Mathematics


Whenever you want to sell options, you have to understand what management techniques can provide you with an improved your risk/reward ratio. In other words, we have to be able to evaluate what's going on in our portfolio in order to keep track of our breakeven points, profit targets and exit strategy opportunities. Don't be the type of investor who just sells an options and prays for a happy outcome. Managing an options portfolio requires you to analyze whether your portfolio isn't subject to huge directional risk or is set to breach a breakeven point.

When selling a short strangle, we collect a put and call premium and have a delta-neutral strategy right from the start. Nevertheless, stocks whipsaw as do their options deltas. In order to keep our portfolio in a well-balanced shape, we have to keep a keen eye on our two breakeven points and adjust when necessary and urgent. As of today, premium members have access to our new spreadsheet calculating the returns of selling short strangles and iron condors. This article serves as a manual of how to use the short strangle calculator utilizing Next Era Energy as a real-life trade example.

Premium members now have access to covered-call, cash-secured, iron condor and short strangle calculators which will show them what the impact of certain transactions is on their profit potential, breakeven point, returns when rolling et cetera. Hopefully next year, all of this information including webinars and updates on our real-life portfolio will be integrated in a fully customized app. Become a premium member by visiting this page.

Let's put the calculator to work

Last week, I sold a bunch of premium in Next Era Energy and made a lot of adjustments to my short strangles along the road as I started with deltas of about 12. Below, you have an overview of what I'm going to address in this article. So far, I've received $369 in cash premium doing one lot strangles (at the moment I sold more than one strangle).

  • When I sold the 200/230 strangle expiring on October 18, 2019, NEE shares were trading at $218.56.

  • The put premium received and the call premium I got paid amounted to 90 cents per contract and 82 cents per contract respectively. The aggregate amount is $172 per one lot.

  • Shares rose slightly and that caused my put delta to contract. My initial downside risk protection (from $218.56 all the way down to $200) stood at 10.23% but increased to 11.35% with shares trading at $220.78.

  • My initial upside risk protection (from $218.56 up to the call strike of $230) was 6.02% and declined to 4.96%.

  • Put breakeven was $198.28

  • Call breakeven was $231.72

Rolling up our puts for the first time

  • The put premium decreased to 50 cents, while the call premium rose to 1 dollar. I decided to take a look at rolling up my puts to receive more credit and up my breakeven point on the call side.

  • When we decide to buy back the put option, this is a cost to us. We roll up the put option to collect more premium in exchange for a higher breakeven point on the put side.Our net put premium is now 90 cents (initial credit for the 200 put) minus 50 cents (cost to close out the 200 put) plus $1.20 (initial credit for the 210 put). This represents a net put premium of $1.60 per one lot.

  • We didn't change our call strike as NEE shares were ticking higher (instead of declining which would lead to rolling down the calls).

  • Compared to our initial situation, we received an additional 70 cents in cash premium which helps improve our breakeven on the call side from $231.72 to $232.42.

  • Our breakeven on the put side is a very comfortable $207.58.

Rolling up for the second time

NEE shares continued to show resilience but remained below the $230 before I once again rolled up my put strike from $210 to $220 to move my breakeven point on the call side even farther away. Let's have a look at the mathematics behind rolling from $210 up to $220.

  • The put premium for the $210 dwindled to just $0.63

  • The call premium increased to $1.15.

  • NEE shares were trading at $224.98 which caused our upside risk protection on the call to contract from 5.27% to 3.31%. Remember that when we entered our 200/230 strangle, our initial upside risk protection stood at 6.02%.

So, I bought back the $210 puts and sold the $220 puts thereby collecting another $127 in cash premium per one lot short strangle ($242 minus $63 to buyback the $210 puts plus the $190 proceeds for the $220 put).

  • Consequently, our call breakeven point increased to $233.69, while our put breakeven is $216.31.

Here you have a more graphical interpretation of the transactions I executed.

Wrapping up

When instituting rolling up or rolling down strategies, we should have reasons why we're doing these transactions. Let's compare our initial situation to our current position to see whether it made a lot of sense for our portfolio.

  • Initial breakeven on the call side = $231.72 versus current breakeven on the call side = $233.69

  • Initial breakeven on the put side = $198.28 versus current breakeven on the put side = $216.31

  • Initial net credit received = $242 versus current net credit received = $369 (an increase of 52.5%)

  • None of the strikes has been breached yet, which is good!

  • Initial distance between the two breakeven points = $33.44 versus $17.38 now.

By rolling up the puts even when the call strike hasn't been touched yet, our put breakeven increases but we collect more credit which helps increase our breakeven on the call side. We just track the performance of the underlying and adjust accordingly.

If we're dealing with a very volatile underlying, rolling up puts or rolling down calls when none of the strikes has been breached yet might be too dangerous since we're narrowing our profit range. Make sure you know what you're doing!

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