Closing out a Short Guts position where the put side has 0 volume and 0 OI

Question

This spread may not even be available after the holiday is over, but here's my question:

I found a high paying high probability guts trade. If you don't know, a short guts is selling an ITM put and an ITM call. The money is made off the premium and as long as the stock price remains between the call and put at expiration there's no loss. In the trade I'm considering there's something like a 90% chance of break even or better and a damn good chance of very good profit - but how do I close the trade and make money before expiration? Or if the stock starts to slip away from me? And what's going to happen to the value of the contract from my perspective as expiration approaches?

Answer 1

A wide Guts Strangle is a low profit position. It is equivalent to selling the traditional Strangle with the same strikes.

For example, if XYZ is $100 and you sell the $90 call and the $110 put, it's the same thing as selling the $90 put and the $110 call. The time premium will be low and there's a reasonably high probability that you will earn that time premium.

There may be some problems with the Guts that you are evaluating.

If you aren't looking at the bid prices in real time, you may be looking at bad quotes, resulting in the appearance of an overvalued position.

Dividends affect option premium. They increase put price and decrease call price. If there's a pending dividend, it may be skewing the total net premium.

Because these options are deep ITM, they will trade with low time premium. Any excess selling may force the bid below intrinsic value and any option owner who sells will trigger an early exercise as the market maker executes a Discount Arbitrage. The person assigned may be you and you will need to have the cash backing to meet the margin requirement.

If there is a dividend, you are also more likely to experience early assignment.

There's no way to make money on this prior to expiration unless the B/A spreads are wide, you place a BTC order for a lot of price improvement, and someone graciously takes the other side of the trade. FWIW, not gonna happen.

The B/A spread won't be the problem if the stock starts to slip away from you before expiration. What will be is that you're going to be losing money before you reach either short strike. That's because as either option approaches the strike, time premium is going to increase (delta is dropping from near 1.00 to about .50 when ATM). .

Make sure that you have all of your ducks in order before attempting a Guts Strangle

Answer 2

Assuming the options market is sufficiently liquid, you can buy back the options that you sold before expiration.

0 Open Interest and volume could indicate that there isn't a lot of liquidity. You might be stuck having to trade only with the market maker in that security, who can maintain quotes $5.00 wide (i.e. $500 on a 100 lot contract).

If the stock starts to slide then you could either buy back the position, or you could 'hedge' the options by buying or selling the corresponding amount of underlying stock to maintain a neutral delta.

It would be cheaper to do this at the outset, but will require repeated transactions to maintain the neutral delta, so your transaction costs could eat into your profit from the trade. If you're using a broker that charges upwards of $10 per trade, then that can become quite expensive quite quickly.