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.