What it is
You sell a put below today's price and a call above it, same expiry, and own no shares. Both premiums are yours up front. If the stock finishes between the two strikes, both options expire and you keep everything.
"Naked" is the word brokers use for the call side, and it is the whole risk of this trade. With no shares behind it, a call that finishes in the money has to be settled by buying shares at whatever the market wants, and there is no ceiling on that price. Brokers usually require a margin account and a higher options approval level before they allow it.
What has to happen for it to make money
The stock has to stay inside the range set by the two break-evens: the put's strike less both premiums, and the call's strike plus both premiums. Inside that range it profits, most of all between the strikes. It does not care which way the stock leans, only how far it travels.
Falling volatility is the other half of the bet. The two premiums are a price the market set for how much it expected the stock to move. If the stock then moves less than that, the seller wins; if it moves more, the seller loses. A calm market after an anxious one is the case it is built for.
Once it is on
Time decay works on both options at once, so a quiet week is worth twice what it would be to a single short option. The work is watching the side the stock is drifting toward. Sellers commonly decide ahead of time at what loss, or what distance from a strike, they will close or roll that side, because a strangle that is left alone through a big move is how a long run of small wins becomes one large loss.
What goes wrong
A big move in either direction. Down, the put loses all the way to a price of zero. Up, the call loses without a limit. A stock that gaps on earnings or news can carry the position past a break-even overnight, with no chance to act in between.
Volatility rising while you hold it. Even before the stock reaches a strike, a jump in volatility makes both options more expensive to buy back, and the margin your broker asks for usually rises with it, which can force a close at the worst price.
Pros and cons
- Pro: paid in a flat market, whichever way the stock leans.
- Pro: time decay on two options at once.
- Pro: no shares to buy up front.
- Con: the upside risk has no limit.
- Con: a gap past a strike can lose many months of premium at once.
- Con: needs margin, which a broker can raise when it hurts most.
In Restrike
The put and the call are kept as two positions on the Log, since two sold options are not something it folds together; label both with the same strategy and the scorecards read them as one. The margin cushion charges each side in full, which reads a little higher than many brokers hold for a strangle, and that is the cautious side to err on. Brokerage import is read-only, and Restrike never places a trade.