A guts strategy trades an in-the-money call and an in-the-money put on the same stock with the same expiration, where the call strike is below the put strike. A short guts sells both for a net credit and profits if the stock stays between the strikes, with unlimited risk if it moves far in either direction. A long guts buys both for a net debit and profits from a large move either way, with loss limited to the debit minus the distance between the strikes. The break-evens are the call strike plus the net premium and the put strike minus the net premium. This article is educational, not investment advice.
There are two types of guts strategy: short guts and long guts.
Short Guts Options Strategy
A short gut strategy involves selling an In-The-Money (ITM) call option, and an In-The-Money put option of the same stock, at the same expiry date and in equal quantities. This option is a limited profit and an unlimited risk strategy. A short guts strategy has a payoff shape similar to a short strangle or short straddle, but because both options are in the money, more of the premium is intrinsic value that you will usually have to pay back. The short guts option works best when the investor expects there to be little volatility in the stock.
The short guts strategy has two break-even points: upper break-even and lower break-even.
-
Upper Break-even: Strike Price of the Call + Net Premium
-
Lower Break-even: Strike Price of Put – Net Premium
The downside of this strategy is that both strikes are sold In-The-Money which means you could be exercised early, therefore be cautious while trading. Since you are going short in options, you want to stay in this position for a short time. Another disadvantage is that investors can only choose short-term expiry dates. The biggest disadvantage is that there is an unlimited risk which means the losses are not capped.
Using MarketXLS Template
MarketXLS offers a template that automatically calculates the short guts strategy. The only thing the users have to do is input values in the yellow cells. The short guts option is a credit spread because credit is earned upfront to enter into the trade, $1,600 can be earned as credit as seen from the net cash flow section in the image. A bid-ask spread is also provided in the template. It calculates the percentage of the difference between the bid price and the ask price. A large spread means that the prices are fluctuating and the market is volatile.
So the current share price in the image is $242 and the investor decides that the price will remain between $235 and $245 till the next month. If the investor is able to trade within these two prices, they will get a profit. Trading in options is risky, especially when shorting options. If the stock price crosses the strike prices on either side then the investor will be at a loss. Investors earn a limited profit only when the underlying stock price is trading between the two strike prices. Maximum loss is unlimited.
-
Maximum profit = Net premium – (Short Put Strike Price – Short Call Strike Price).
-
Maximum loss = Unlimited above the upper break-even and large below the lower break-even.
Use the Short Gut template to model this strategy in Excel.
Long Guts Options Strategy
A long gut strategy involves buying an in-the-money (ITM) call option and an in-the-money put option of a stock at the same expiry date and in equal quantities. This option is an unlimited profit and a limited risk strategy. It is similar to the long straddle and long strangle strategies except that long guts use in-the-money options. The long guts option works best when the investor expects high volatility in the stock.
Like the short guts strategy, the long guts strategy also has two break-even points: upper and lower break-even.
-
Upper break-even: Strike Price of Long Call + Net Premium
-
Lower break-even: Strike Price of Long Put – Net Premium
A disadvantage of the long-guts strategy is that if the stock price remains stagnant, you would lose money. Another risk is if the volatility falls for the options, then it would cause a loss. A long gut strategy also has more commissions involved than a single option.
Using MarketXLS Template
MarketXLS also has a long guts template for investors. The long guts option is a debit spread, so net debit is paid when the position is opened. The net debit is shown as a negative number in the net cash flow section because $1,658 is taken from the investor’s account to enter into the trade.
Maximum Loss = net premium paid – (put strike price – call strike price) + commissions paid. Loss occurs when the underlying stock price is between the two strike prices of the call and put. This is the complete opposite of the short guts option where it is the profit that occurs when the stock price is between two strike prices. Maximum gain is unlimited for long guts options.
Large gains for the long guts strategy are attained when the underlying stock price makes a very strong move either upwards or downwards at expiration. The move in the underlying stock price must be strong enough such that either the long call or the long put rise enough in value to offset the loss incurred by the other option expiring worthless.
Bottom Line
Once the investor knows about the stock volatility and what he wants from the option, then they will be able to decide which strategy to use. Due to the short guts strategy having an unlimited risk, many investors might not want to use it however, if you know that the stock is going to remain stagnant or within the two strike prices then you can make a profit.