Short Guts
Description
The
Short Guts is a simple adjustment to the Short Strangle that increases the net
credit. Instead of selling out-of-the-money options, we sell in-the-money calls
and puts, which creates a higher net credit.
As
with Short Straddles and Short Strangles, the risk we run with a Short Guts is
uncapped on either side. The Short Guts is precisely the opposite of a (Long)
Guts. We short in-the-money puts and calls with a short time to expiration (one
month or less) in order to pick up income.
Because
we are short options, time decay works for us, so we only select short-term
expiration dates. Also we are exposed to potentially unlimited risk, which is
another reason for making this a short-term strategy. It is not recommended.
The
additional risk you face with a Short Guts is that each of the strikes is
in-the-money, and therefore you could be exercised early, so stay away from
this strategy!
Each
leg of the trade has uncapped downside. If the stock starts going ballistic in
either direction, then your position is precarious to say the least. If the
stock remains rangebound, then you will make a limited profit.
You
would never trade this strategy right before a news event like an earnings
report. You certainly would not want any nasty surprises to be lurking around
the corner.
Market
Opinion
Direction
neutral.
P/L
When
To Use
When
you anticipate no movement in a stock and decreased volatility from what had
been high volatility.
Example
XXXX
is trading at $25.37 on May 14, 2011.
Sell
June 2011 $22.50 strike call for $3.30.
Sell
June 2011 $27.50 strike put for $2.80.
Net
credit: premiums sold = $6.10
Benefit
The
benefit is a possible high yield from a rangebound stock.
Risk
vs. Reward
The
risk is unlimited with this position. The reward is limited to the net credit
you receive minus the difference in strike prices.
Net
Upside
Net
credit minus difference in the strike prices.
Net
Downside
Unlimited
downside.
Break
Even Point
Break
even up: higher strike plus net credit minus difference in strikes.
Break
even down: lower strike minus net credit plus difference in strikes.
Effect
Of Volatility
Negative
when the position is profitable, and positive when the position is not
profitable.
Effect
Of Time Decay
Positive.
You are short in options so you want to be in this position for as little time
as possible.
Alternatives
Before Expiration
You
can buy back the options you sold to stem a loss.
Alternatives
After Expiration
Unravel
the position by buying back the puts and calls.