To apply a covered strangle strategy in low-volatility markets, you combine holding a stock with selling both a call and a put option on the same stock. This strategy works well in low-volatility environments because it allows you to generate income through option premiums while limiting risk. Since the market isn’t expected to move sharply in either direction, the options you sell are less likely to be exercised, giving you the potential to keep the premiums as profit.

What Is a Covered Strangle Strategy?

A covered strangle involves holding a stock while selling both a call option (which gives the buyer the right to buy the stock) and a put option (which gives the buyer the right to sell the stock) on the same underlying asset. Both options have strike prices set outside the current market price, and they expire at the same time. This strategy can generate income from the premiums received for the options, but it also limits potential gains if the stock price moves outside of the range defined by the strike prices.

Why Use a Covered Strangle in Low-Volatility Markets?

In low-volatility markets, the stock price tends to move within a relatively narrow range. This means that the call and put options you sell have a lower likelihood of being exercised, which makes this strategy attractive for generating income without taking on significant risk. By selling options with strike prices far from the current market price, you’re able to collect premiums without much worry of the options being exercised, making it an ideal strategy when market movements are expected to be minimal.

How to Set Up a Covered Strangle?

To set up a covered strangle, follow these steps:

• Own the underlying stock. Ensure you have a sufficient number of shares to cover the position.
• Sell a call option with a strike price above the current market price.
• Sell a put option with a strike price below the current market price.
• Ensure both options expire at the same time and have a time frame that fits within the expected low-volatility market period.
• Monitor the stock and options positions to track any changes, especially as expiration approaches.

The premiums received from selling both options will be your income from the strategy.

What Are the Risks of a Covered Strangle?

While the covered strangle is a relatively low-risk strategy, it does come with certain risks:

• If the stock price moves sharply in either direction (up or down), you could face significant losses. Although your stock position will offset some of the losses, your potential gains are still limited by the options you've sold.
• If the stock price rises above the call option strike price, your stock will be called away, and you’ll miss out on any further gains.
• If the stock price falls below the put option strike price, you may be obligated to purchase additional shares at the strike price, potentially leading to losses if the price continues to drop.

Therefore, this strategy works best in low-volatility markets where large price movements are less likely.

When to Close or Adjust a Covered Strangle Position?

You may want to close or adjust your covered strangle position if:

• The stock price starts moving closer to the strike prices of your options, increasing the likelihood of exercise.
• The market becomes more volatile than expected, which may lead to greater risk than you’re willing to take.
• You wish to lock in profits or cut losses as expiration approaches, especially if the options have already gained value.

Adjusting the position or closing it early can help mitigate risks and protect your profits.