Options Trade of the Day: Short Strangling Inc.

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Shares of online retail giant Inc. ( AMZN ) have rallied more than 2% so far today, as traders offered up a mutedly bullish response to news that the company has opened an online grocery service in the U.K. Proving that they are willing to speculate on nearly any tidbit of news, options traders have piled into AMZN calls this afternoon, with more than 15,000 of these typically bullish contracts changing hands. Overall, call volume has more than doubled AMZN's daily average, with the July 120 strike receiving the lion's share of the attention.

Rummaging through AMZN's call activity, I found a rather interesting trade at the July 130 strike. Specifically, 101 contracts traded on AMZN's July 130 call at 11:58 a.m. Eastern time on the Chicago Board Options Exchange ( CBOE ) for the bid price of $0.12, or $12 per contract. Simultaneously, 101 July 100 puts crossed the tape on the same exchange for the bid price of $0.25, or $25 per contract. Given this data, it would appear that we are looking at a short strangle on

AMZN July 100 put and July 130 call volume details

While a long strangle anticipates a sharp move in the underlying stock beyond the purchased strikes, a short strangle is a strategy that requires the equity to remain pinned between the two sold strikes. Basically, a short strangle is a bet that the security will remain in a trading range, thus allowing the sold options to expire worthless, and the trader to retain the entire premium received at initiation.

The Anatomy of an Short Strangle Position

Getting down to business, the trade breaks down like this: The trader receives a credit of $2,525 for selling 101 July 100 puts -- ($0.25 * 100) * 101 = $2,525. Meanwhile, the trader receives an additional credit of $1,212 for selling 101 July 130 calls -- ($0.12 * 100) * 101 = $1,212.

So, we have one sold July 100 put for every sold July 130 call, and the trader has pocketed a premium of $3,737 -- ($2,525 + $1,212) = $3,737. The breakdown for this short strangle position is listed below:

AMZN short strangle breakdown

The sweet spot for this trade lies between $100 and $130 per share. If AMZN closes within this range on July 16, when these options expire, the trader will be able to keep the entire $3,737 credit, which represents the maximum profit for this trade.

Meanwhile, there are two breakeven points for this position. The first is equal to the sold 100 strike minus the net credit received, or $99.63 -- 100 - 0.37 = $99.63. The second is equal to the sold 130 strike plus the net credit received, or $130.37 -- 130 + 0.37 = $130.37.

Finally, the maximum loss is theoretically unlimited to the upside, as there is no limit to how high AMZN could rally. On the downside, losses are potentially heavy, but limited to the sold 100 strike minus the net credit received. In this case, losses on a plunge in AMZN shares are limited to $99.63, or $9,963 per contract. Below is a chart for a visual representation of this trade's profit/loss scenario:

AMZN short strangle profit/loss chart

Implied Volatility

After the short strangle has been established, rising implied volatility becomes the bane of the trader's existence, so to speak. As implieds increase, the prices of the two sold options also increase, making an exit that much more expensive, should the trader need to cut and run. At the time of the trade, implieds for the July 130 call arrived at 42.18%, while the implied volatility for the July 100 put came in at 58.81%. For a point of reference, AMZN's one-month historical volatility was 41.84% as of the close of trading on Wednesday.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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