Potential Starbucks (SBUX) Trade Using the Highest-Probability Options Strategy

Potential Starbucks (SBUX) Trade Using the Highest-Probability Options Strategy

short-strangle-starbucks

Statistically speaking, it doesn’t get much better than the short strangle.

Many professionals claim it’s the ultimate options strategy. And there is no doubt it is the bread-and-butter options strategy among most traders that take a quantitative, or mathematical approach to trading options.

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Today, he publishes four different specialized options services for Cabot Wealth Network.

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These services each offer a safe way to generate reliable returns – based on statistical likelihoods that give you an 80% chance of success.

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A short strangle is a neutral, range-bound options strategy (short call and short put) that has undefined risk and limited profit potential. Typically, a short strangle has little to no directional bias. And, like most options selling strategies, short strangles benefit from a decline in implied volatility (IV) and passage of time (time decay).

Before I get to an example, I want to point out that short strangles require more capital. The reason is because we are selling naked options on both sides. But, don’t let that scare you.

In return for the larger capital outlay, an options trader is rewarded with one of the highest-probability options strategies in the investment universe. I’m talking an 85% probability of success. But hey, that’s one of the great things about selling options, using defined or undefined options strategies: you get to choose your probability of success on every trade you place.

But, there is one important caveat when trading short strangles.

Short strangles only work for the disciplined options trader. If you are not disciplined when it comes to risk management, naked options aren’t for you. I would suggest looking at iron condors. Iron condors are risk-defined.

That said, I would question why bother trading options or stocks if risk management isn’t your #1 priority, regardless of the strategy you choose. Just go to the casino. Use the numbers in front of you to make sound decisions. Allow the probabilities to lead the way…all you need to do is create a disciplined risk-management approach and the Law of Large Numbers will take over. You will hear me say this repeatedly—all successful options traders have a rigid risk-management plan. Without it, failure is inevitable.

But I can’t emphasize enough: If you have the capital (taking position size into account) and look at yourself as a risk manager first and options trader second, well, this could be your new favorite strategy. There is a reason short strangles are the bread-and-butter options strategy for most professional options traders.

Let’s look at an example on how short strangles work.

As I said before, strangles, like all options selling strategies, benefit from a decline in implied volatility (IV) and passage of time (time decay). So, the first step is finding a highly liquid stock or ETF that has a heightened level of implied volatility.

Look no further than the current IV rank and IV percentile of the stock. I currently publish a list of ETFs with associated IV ranks and IV percentiles. I will be doing the same with a select group of highly liquid stocks in the near future. Stay tuned!

IV rank tells us if the current level of volatility in a stock is higher compared to the levels over the past year. Since we are selling options in the form of a short strangle, we prefer options prices to be inflated.

IV percentile tells us the percentage of days that implied volatility has traded below its current level of implied volatility over the past year.

Right now, Starbucks (SBUX) fits the bill.

So, let’s take a look at a potential trade.

The stock is currently trading for 91.34.

short-strangle-SBUX-starbucks

The next item is to look at SBUX’s expected move for the expiration cycle that I’m interested in.

The expected move or expected range over the next 23 days can be seen in the pale orange colored bar below. The expected move is from 87 to roughly 95, for a range of $8.

short-strangle-sbux

Knowing the expected range, I want to, in most cases, place the short call strike and short put strike of my short strangle outside of the expected range, in this case outside of 87 to 95.

This is my preference most of the time when using strangles. I want my short strangle to have a high probability of success.

If we look at the call side of SBUX for April 22, 2022, expiration, we can see that the 97 call strike offers an 85.35% probability of success and the 98 call strike offers us an 88.70% probability of success. Both strikes are above the edge of SBUX’s expected move, or 95.

Now it’s just a matter of what kind of return we are looking for on the trade. In this example, I’m going with the 97 call strike with a 85.35% probability of success. I should be able to sell the call strike for $0.45.

short-call-sbux-starbucks

Now let us move to the put side. Same process as the call side. But now we want to find a suitable strike below the low side of our expected move, or 87. The 84, with an 84.78% probability of success, works.

short-put-sbux-starbucks

We can create a trade with a nice probability of success if SBUX stays between our 13-point range, or the 97 call strike and the 84 put strike. Our probability of success on the trade is 85.35% on the upside and 84.78% on the downside.

I like those odds.

Here is the trade:

Simultaneously:

Sell to open SBUX April 22, 2022, 97 calls

Sell to open SBUX August 22, 2022, 84 puts for roughly $0.95 

short-strangle-price-SBUX

Our margin requirement is $1,246.50 per short strangle.

Again, the goal of selling the SBUX short strangle is to have the underlying stock, in this case SBUX, stay below the 97 call strike and above the 84 put strike through expiration in 23 days.

In most cases I would look to take the trade off when I can lock in 50% to 75% of the premium sold, or $0.50 to $0.25. Moreover, I will get out of the trade if it hits 2 to 3 times my original credit, or roughly $2.00 to $3.00.

Here are the parameters for this trade:

  • The Probability of Success – 85.35% (call side) and 84.78% (put side)
  • The max return on the trade is the credit of $0.95, or 7.6%
  • Break-even level: 97.95 – 83.05
  • The maximum loss on the trade is in theory unlimited. Remember, we will adjust if necessary and always stick to our stop-loss guidelines. Position size, as always, is key.

Short strangles offer options traders one of the highest-probability strategies out there. And that’s why they are one of the strategies of choice amongst professional options traders. Undefined risks strategies can be scary for the uninitiated. But if you understand the risk of the strategy and are diligent with your risk management, a whole new world of trading has just opened up.

Comments

  • David R.

    Andy,

    I cant get expected move on Tasty Works and TOS to equate. They’re always off by $2-$5. Do you think that’s alot? Which would you rather use?

    Thanks

    • Andy C.

      David,

      Are you looking at the same expiration cycle for both? If I see a discrepancy I tend to go with the most conservative range. I hope this helps.

    • Andy C.

      Randy,

      I use Tastyworks and Thinkswim to fin the expected move/range. I’m certain other platforms offer it as well, but the two aforementioned are the two I use. I hope this helps.

  • Thanks for sharing. Would you consider rolling the untested out side up or call side down to manage the trade?

    • Andy C.

      Kevin,

      Thanks for the question. I typically roll the untested side as all research points to this being the most effective move. I hope this helps.

  • Bight B.

    no, the worst case is wiping out your account. ‘The maximum loss on the trade is in theory unlimited.’ Of course, you can set stops and manage the position. But a dramatic jump in price overnight could be disastrous, etc.

    • Andy C.

      Bight,

      Thanks for the comment. This is why I only use short strangles on lower beta stocks and not high flyers. Even if SBUX were to move 2 std. deviations it would still be within our reach as seen by the deltas on the trade. Again, there is a reason why professionals use short strangles on reasonable stocks. People get in trouble when they look at premiums over probabilities and other statistical factors. I hope this helps.

  • Harry P.

    Sinking would not be my worst case scenario. Remember, don’t sell a put on a stock you wouldn’t want to own. My concern is if it shoots up. Earnings are the week after expiration and I would prefer to be out before then.

    • Andy C.

      Harry,

      Agreed. And it is also why I chose the expiration prior to earnings. Even if it shot higher it would still be within our stop loss guidelines, due to the low delta on the call side. I hope this helps.

      • Andy C.

        Let’s see they don’t even have a call strike for $1000. 🙂 I understand what you are saying and it’s unfortunately a misconception about short strangles, especially if you use them responsibly. As I stated in another comment. This is why I only use short strangles on lower beta stocks and not high flyers. Even if SBUX were to move 2 std. deviations it would still be within our reach as seen by the deltas on the trade. Again, there is a reason why professionals use short strangles on reasonable stocks. People get in trouble when they look at premiums over probabilities and other statistical factors. I hope this helps.

      • Andy C.

        If you went out the the furthest expiration cycle, which is January 19, 2024 (659 days), the furthest out strike is 175 and the 175 call strike of 5.02% of touching. Basically, the probabilities of a move to $1000 would be miniscule. But hey, people that don’t understand risk management, position-size, etc. and aim for large levels of premium first and foremost are typically the ones that suffer from using short strangles. Again, there is a reason why one of the bread and butter strategies for most professionals is the short strangle. You can always buy OTM calls and puts as a form of insurance, but position-size should be where risk-management starts. And hey, if you can’t afford to trade short strangles while keeping your position-size at reasonable levels then iron condors are a good alternative. But there are probability limitations with iron condors. Essentially, if you are not able to trade short strangles while keeping your position-size within reason then you shouldn’t be trading them…it’s really that simple. I hope this helps a few of you.

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