With December options expiring this Friday, you might be able to pick up some quick money over the next two days by selling some S&P 500 Index options using a strategy called a strangle.

Before going into the specifics, you must understand that this position poses risks that, while not unreasonable, are unlimited. This strategy should not be employed by those with faint hearts or shallow pocket books.

The strangle is a position involving out-of-the-money puts and calls on a one-to-one basis. The puts and calls have different strikes but the same expiration. The difference between a strangle and a straddle is that the straddle uses puts and calls with the same strike.

You can either go long by buying both the puts and calls, or short, as in this case, by selling both sides.

Staying in Range

Looking at a chart of the S&P 500 one can see that it has established a general trading range over the past two months between 860 and 925. The mid-point of that range, roughly 895, also represents fulcrum of trading going back to mid-July. Basically that's the battle line between the bulls and the bears.


Looking for Quick Profits?
Be very careful; this approach isn't for all
Source: Prophet Financial Systems Inc.

As the year winds down, I'm betting that neither side will gather enough momentum to push the S&P 500 too far from this fulcrum of 895. At least hopefully not in the next two days.

With the index trading at 890 at midday on Wednesday, one can sell the December 900 call for $4.20 and simultaneously sell the December 880 put for $4.30. The total credit for the strangle is $850. This $850 is the combined premium value of the shorted strangle, and it also represents the maximum possible profit. Should both the put and call expire out-of-the-money, and therefore become worthless, the seller would retain the premium.
Premium Profit
The most you can make is the sale price
Option Value Break-Even Points
Dec 900 Call $420 908.50
Dec 880 Put 430 871.10
Net Profit/ Loss 850 0
Source: TSC Research

The maximum profit of $850 per strangle is achieved if the index settles between 880 and 900, rendering both the put and call worthless. The break-even points are 908.50 to the upside and 871.10, a move of 18.5 points, or 2.1%, from the current 890 price level.

For every point the index moves beyond the break-even points, we will incur a loss of $100 per strangle. Look at various potential settlement prices and the resulting profit or loss.

Note that the exercise-settlement value is calculated using the opening (first) reported sales price in the primary market of each component stock on the last business day (Friday) before the expiration date. But be aware that the last trading day in S&P 500 options is on Thursday. The actual expiration is on Saturday and the contract settles in cash, meaning unlike stock options, the exercise doesn't result in a long or short position.


Could Be Painful
If you lose, you can lose big
Index Price Strangle Value Profit (Loss)
925 $2500 ($1650)
900 0 850
875 500 350
850 3000 (2150)
Source: TSC Research
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Steve Smith.