Stocks and Commodities Magazine
Trading Strangles with Commodities in the Futures Market (Part 2 of 3)
If strangle traders can make money regardless of market direction, doesn’t it provide the best odds of success? (Part 2 of 3)
In last month’s column we focused on the advantages, but mostly disadvantages, of buying option strangles. This month, we’ll discuss the strategy of selling options strangles, which I believe to offer traders much better odds of success.
In essence, this is the simultaneous, or near simultaneous, sale of calls and puts of the same underlying futures contract. In contrast to a strangle buyer, who is betting on the market making a large move in either direction, the seller of a strangle is speculating on lack of volatility. Rather than paying money up front to place their wager, option sellers collect cash (known as premium) in exchange for the liability of paying off the option buyer should the circumstances warrant it (i.e. the futures price is beyond the strike price at expiration). Very bluntly, the strangle buyer is betting that something will happen; the seller is taking the bet with the assumption that nothing will happen.
This strategy is similar to that of casinos, or insurance companies, in that they bring in limited revenue in exchange for unlimited (or at least very large) risks, but they hope that over time the small premiums collected outweigh the lower probability payouts. If you’ve ever played the lottery, you know that your risk is a few dollars but your potential reward could be large; option selling is taking the side of the “house”.