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Short Guts
The short guts is a neutral strategy in options trading that involve the simultaneous selling of an in-the-money call and an in-the-money put of the same underlying stock and expiration date.
| Short Guts Construction |
| Sell 1 ITM Call Sell 1 ITM Put |
This is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term. The short guts is a credit spread as a net credit is taken to enter the trade.
Limited Profit Potential
Maximum gain for the short guts strategy is limited and occurs when the underlying stock price on expiration date is trading between the strike prices of the options sold. At this price, while both options expire in the money, they have lost all their time value. It is this loss in time value that the short guts strategy aims to capture as profit.
The formula for calculating maximum profit is given below:
- Max Profit = Net Premium Received + Strike Price of Short Put - Strike Price of Short Call - Commissions Paid
- Max Profit Achieved When Price of Underlying is in between the Strike Prices of the Short Call and the Short Put
Unlimited Risk
Large losses can be experienced when the underlying stock price makes a strong move either upwards or downwards at expiration.
The formula for calculating loss is given below:
- Maximum Loss = Unlimited
- Loss Occurs When Price of Underlying < Strike Price of Short Put - Net Premium Received OR Price of Underlying > Short Call + Net Premium Received
- Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received + Commissions Paid
Breakeven Point(s)
There are 2 break-even points for the short guts. The breakeven points can be calculated using the following formulae.
- Upper Breakeven Point = Net Premium Received + Strike Price of Short Call
- Lower Breakeven Point = Strike Price of Short Put - Net Premium Received
Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a short guts strategy by selling a JUL 35 call for $600 and a JUL 45 put for $600. The net credit received when entering the trade is $1200.
If XYZ stock rallies and is trading at $50 on expiration in July, the short JUL 45 put will expire worthless but the short JUL 35 call expires in the money and has an intrinsic value of $1500. Buying back this short put to close the position requires $1500. Subtracting the initial credit of $1200, the options trader's loss comes to $300.
However, if on expiration in July, XYZ stock is still trading at $40, both the JUL 35 call and the JUL 45 put expire in the money with $500 in intrinsic value each. As the options trader had received $1200 when entering the trade, and closing the position requires only $1000, a profit of $200 is made.
Long Guts
The converse strategy to the short guts is the long guts. Long guts are employed when large movement is expected of the underlying stock price.