Shopify stock has traded in a range from 35 to 45 since the start of August. For an option trader who thinks Shopify stock may stay in that range, a short strangle option trade is a way to make a profit if it does.
Why A Short Strangle?
A short strangle trade benefits if Shopify stock stays within a trading range. This option trading strategy involves selling an out-of-the-money put and an out-of-the-money call with the same expiration date.
This trade generates a large amount of premium for the option seller, but it does come with risks. A short strangle is an unprotected trade, sometimes referred to as a "naked" trade. Naked options can be risky as they expose the trader to potentially unlimited losses if the stock makes a big move in either direction.
However, if the trader is right and SHOP stock trades sideways, large gains are also possible.
Setting Up The Trade For Shopify Stock
With Shopify stock trading just below 40, a short strangle could use a 36 put and a 46 call both with September expirations.
Yesterday, the 36 put traded for around $1.75 and the 46 call was around $1.35.
Selling those two options generates a total of $310 in premium. That is the maximum possible gain on the trade if SHOP stock finishes between 36 and 46 on the day of expiration.
To work out the breakeven price of the trade, take the strike prices plus and minus the total premium received of $3.10 per share. That sets the breakeven prices for the short strangle at 32.90 and 49.10. Moving outside of that range at expiration leads to losses.
A Short Strangle Is An Advanced Strategy
This trade is a short vega trade. That means an increase in implied volatility early in the trade is bad for profits. At the moment, implied volatility on Shopify stock is around 72%, which is above average for the last 12 months.
Short strangles are an advanced option strategy, so if all that sounds confusing, it's best not to trade them.
With a trade like this the potential losses are unlimited and a lot higher than the potential gains, so traders would want to be very confident that the stock is going to remain flat over the course of the trade.
According to IBD Stock Checkup, SHOP stock ranks No. 47 in its group and has a Composite Rating of 32, an EPS Rating of 53 and a Relative Strength Rating of 8.
Please remember that options are risky, and investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
