Covered Straddle Explained

Covered Strangle Options Trading Strategy Explained

Published on Thursday, August 9, 2020 | Modified on Wednesday, June 5, 2020

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Covered Strangle Options Strategy

The covered strangle option strategy is a bullish strategy. The strategy is created by owning or buying a stock and selling an OTM Call and OTM Put. It is called covered strangle because the upside risk of the strangle is covered or minimized.

The strategy is perfect to use when you are prepared to sell the holding or bought shares at a higher price if the market moves up but would also is ready to buy more shares if the market moves downwards.

The profit and in this strategy is unlimited while the risk is only on the downside.

When to use Covered Strangle strategy?

A covered strangle strategy can be used when you are bullish on the market but also want to cover any downside risk. You are prepared to sell the shares on profit but are also willing to buy more shares in case the prices fall.

Example

Suppose shares of ABC company is currently trading at в‚№ 200. You buy 100 shares of the company or are already holding it. You sell an OTM Call at the strike price of в‚№ 210 at a premium of в‚№ 10 per share and OTM Put at the strike price of в‚№ 190 at в‚№ 8 per share. The lot size is 50 shares.

Covered straddle

Covered straddle

Covered Straddle

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Covered Straddle

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Categories: Derivatives, Stocks

In a covered straddle, the investor owns a stock they think will go up. In order to make the most of it, they sell calls and puts with the same strike price on the stock. Since they think the stock will go up, they sell the calls at a higher price. If the stock goes up like they think it will, they make lots of money. if it stays the same, they make a little money. If it goes down. they lose money. Potentially a lot of it.

So basically, the strategy is “covered” unless the investor is a moron who thought a stock would go way up and it actually went down.

Related or Semi-related Video

Finance: What are short cover and squeez. 7 Views

finance a la shmoop what is short-covering

and squeezing the shorts hmm alright ever see anyone walk uncomfortably out

of the target changing room wearing something the clothing designer never [Man wearing tight clothing by changing room]

intended to fit onto that body yeah that would be squeezing the shorts in in Wall

Street speak the term is kind of related a given stock has a float of say a

hundred million shares and averages trading of three million shares a day

well there’s a big hedge fund that’s convinced the company’s cancer curing [Woman gulps a pill]

drug will actually only turn the users toenails bright green and all of this

will come to light soon the stock will sell off big so they shortened short and

short recall that short selling is when an investor borrows stock betting that

the stock will go down in price and then sells it so yeah that’s how it works

they essentially borrow securities from the brokerage with whom they’ve set up [Stock transfers from brokerage to hedge fund]

the short selling arrangement those shares get sold at whatever price

they’re trading out at the time that the short sales happen the hedge fund then

waits until the stock falls to its target price hoping that it actually [Cancer B Gone stock price falls]

falls and doesn’t go the wrong way at which point it then buys back the stock

more cheaply delivering it back to the brokerage and booking what is you know

hopefully a hefty profit right so they’d shorted it a hundred and then it falls

to 80 and they buy it back and make twenty bucks a share but things don’t

always work out according to the best laid plans of hedge funders and men so

cancer begun stock climbs despite the hedge fund having bet that it would go [Cancer B Gone stock increases]

down well in horror the hedge fund watches as the stock climbs from 80 to

82 to 85 to 90 with the fund all the more sure it’s worth 10 bucks a share

after continued shorting of more and more and more shares betting on the [People in meeting looking unhappy]

downfall of cancer be gone while the hedge fund wakes up in more horror one

morning to read the cover The Wall Street Journal which says the drug [Man reading newspaper]

actually works so the CBG shoots suddenly to $200 the

next moment leaving the hedge fund now with an average short sale price of

around 85 bucks a share the hedge fund is $115 a share in losses now that’s per

share times the 10 million in shares it shorted and remember it

only trades 3 million a day on an average day that’s three days and change

of short position on this stock the loss on this short has wiped out all the

games for the year of the hedge fund and worse the stock now has virtually [Stock price rises]

unlimited upside as cancer curing you know is a thing

so the hedge fund is squeezed why squeezed well it’s short position is [Man squeezes hedge fund water bomb and it pops]

squeezed because now it absolutely has to buy back the shares at the $200 plus

price and it has to buy him back because the odds of this stock Falls or goes

down with all the positive headlines coming from journalists all around the

world about cancer being cured well pretty low right stock probably going to

300 400 who knows but it’s going up so the hedge fund will have to capitulate [Man giving speech on stage]

that it was wrong in shorting in the first place and all of its competitors

know this fact as they carefully track the short position on the stock noting

that some 50 percent of the hundred million total shares or 50 million

shares that were floating were in fact short enormous short position like this

one hedge fund wasn’t the only one betting it would fall so being the

kindly loving people that hedge funders are the competitors will be buying the [Competitors give money to brokerage]

snot out of the stock for a while bidding to 20 to 30 to 40 until enough

volume and shares transacting passes so that the hedge funds will have covered

their shorts meaning the guys who shorted it at a hundred bucks have to

pay to twenty to thirty to forty whatever the price is to unwind their

shorts before the stock goes the 300 400 500 and bankrupts them that’s getting

squeezed that’s how short squeezes work and

punishes hedge funders for ill-timed bets that are wrong and yeah you don’t bet [Hedge funders sitting at a table]

against a curing cancer at least hopefully not in our world the position

there in those shorts being SQUOZE is uncomfortable like this uncomfortable [Man in tight pants in a changing room]

COVERED STRADDLE

Option strategy in which the investor writes the same number of calls and puts with the same maturity and strike price on his stock. Not a true covered position, assignment for the short put requires additional stock. Also known as bullish strategy.