A strangle is an options trading method that rewards traders who correctly predict whether a stock’s price will rise, fall, or remain inside a narrow range.
Investors can earn from a long strangle when the price of a company moves dramatically and from a short strangle when the price stays within a certain range. So let’s examine how they operate to help you decide if strangles are appropriate for your investment strategy.
What is Strangle Options Strategy?
In a strangle, options are used to make predictions about whether or not the price of a stock will fluctuate considerably. For example, buying or selling a call option with a strike price above the stock’s current price and a put option with a strike price below the current price constitutes executing a strangle.
What is Long Strangle Options Strategy?
The long strangle options strategy is a position with defined risk because the total premium paid to buy the call and put represents the position’s maximum loss. Generally, one side will lose money when the other is lucrative since the two possibilities are directionally opposed.
Long strangles may be lucrative before expiration even if there is no move in-the-money (ITM). Still, for every day that passes with no movement in the stock price, the extrinsic value premium may decline for both options.
How does it work?
1. Outlook
One should have a neutral view of the stock or the index.
2. Strategy
This strategy involves-
- Buy an out-the-money (OTM) call option
- Buy an out-the-money (OTM) put option
- Both the options belong to the same underlying
- Both the options belong to the same expiry
Nifty Spot – 15400
Long Strangle trade set-up –
- Buy 15800CE – ₹ 44.2
- Buy 15000PE – ₹ 69.8
3. Maximum loss/risk
Potential losses are limited to the net debit paid.
4. Profit
Potential profit is theoretically unlimited if the stock goes up.
If the stock goes down, potential profit may be substantial but limited to strike A minus the net debit paid.
5. Breakeven stock price at expiration
At expiration, the underlying stock price must either increase above the call strike price or decline below the put strike price in order for a long strangle to break even.
The underlying stock price must increase or decrease by the same total premium that was expended to open the position beyond the call or put’s strike price.
6. Payoff Diagram
Below is the pay-off diagram for this strategy-
You can also read our blog on 12 Common Option Trading Strategies Every Trader Should Know
What is Short Strangle Options Strategy?
The short strangle options strategy allows investors to profit when a stock’s price does not change considerably. For example, investors use a short-strangle strategy to sell put options with strike prices below the current share price and call options with strike prices above the current share price.
The investor makes money if the stock price remains within the range of the option strike pricing. The investor could lose money if it fluctuates outside of that range. When the difference between the two strike prices is lower, profits are typically bigger.
How does it work?
1. Outlook
One should have a neutral view of the stock or the index.
2. Strategy
This strategy involves-
- Sell an out-the-money (OTM) call option
- Sell an out-the-money (OTM) put option
- Both the options belong to the same underlying
- Both the options belong to the same expiry
Nifty Spot – 15400
Long Strangle trade set-up –
- Sell 15800CE – ₹ 44.2
- Sell 15000PE – ₹ 69.8
3. Maximum loss/risk
If the stock goes up, your losses could be theoretically unlimited.
If the stock goes down, your losses may be substantial but limited to strike A minus the net credit received.
4. Profit
Potential profit is limited to the net credit received.
5. Breakeven stock price at expiration
The two breakeven points for a short strangle can be calculated using the following formulas:
Upper Breakeven Point = Strike Price of Short Call + Net Premium Collected
Lower Breakeven Point = Strike Price of Short Put – Net Premium Collected
6. Payoff Diagram
Below is the pay-off diagram for this strategy-
Strangle vs Straddle Option Strategy
As similar tactics, the straddle and strangle have comparable risk attributes.
The main distinction between a straddle and a strangle is the use of at-the-money (ATM) options in constructing a straddle as opposed to out-of-the-money (OTM) options in constructing a strangle. A call and put from the same expiration cycle are used in both methods.
Bottomline
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