What Is a Strangle?
A strangle is an options strategy in which the investor holds a position in both a call and a put option with different strike prices, but with the same expiration date and underlying asset. A strangle is a good strategy if you think the underlying security will experience a large price movement in the near future but are unsure of the direction. However, it is profitable mainly if the asset does swing sharply in price.
A strangle is similar to a straddle but uses options at different strike prices, while a straddle uses a call and put at the same strike price.
Key Takeaways
- A strangle is a popular options strategy that involves holding both a call and a put on the same underlying asset.
- A strangle covers investors who think an asset will move dramatically but are unsure of the direction.
- A strangle is profitable only if the underlying asset does swing sharply in price.
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How Does a Strangle Work?
Strangles come in two directions:
- In a long strangle—the more common strategy—the investor simultaneously buys an out-of-the-moneycall and an out-of-the-money put option. The call option's strike price is higher than the underlying asset's current market price, while the put has a strike price that is lower than the asset's market price. This strategy has large profit potential since the call option has theoretically unlimited upside if the underlying asset rises in price, while the put option can profit if the underlying asset falls. The risk on the trade is limited to the premiumpaid for the two options.
- An investor doing a short strangle simultaneously sells an out-of-the-money put and an out-of-the-money call. This approach is a neutral strategy with limited profit potential. A short strangle profits when the price of the underlying stock trades in a narrow range between the breakeven points. The maximum profitis equivalent to the net premium received for writingthe two options, less trading costs.
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Strangle vs. Straddle
Strangles and straddlesare similar options strategies that allow investors to profit from large moves to the upside or downside. However, a long straddle involves simultaneously buyingat the moneycall and put options—where the strike price is identical to the underlying asset's market price—rather than out-of-the-money options.
A short straddle is similar to a short strangle, with limited profit potential that is equivalent to the premium collected from writing the at the money call and put options.
With the straddle, the investor profits when the price of the security rises or falls from the strike price just by an amount more than the total cost of the premium. So it doesn't require as large a price jump. Buying a strangle is generally less expensive than a straddle—but it carries greater risk because the underlying asset needs to make a bigger move to generate a profit.
Pros
Benefits from asset's price move in either direction
Cheaper than other options strategies, like straddles
Unlimited profit potential
Cons
Requires big change in asset's price
May carry more risk than other strategies
Real-World Example of a Strangle
To illustrate, let's say that Starbucks (SBUX) is currently trading at US$50 per share. To employ the strangle option strategy, a trader enters into two long option positions, one call and one put. Thecall has a strike of $52, and the premium is $3, for a total cost of $300 ($3 x 100 shares). The put option has a strike price of$48, and the premium is$2.85, for a totalcost of$285 ($2.85 x 100 shares). Both options have the same expiration date.
If the price of the stock stays between $48 and $52 over the life of the option, the loss to the trader will be $585, which is the total cost of the two option contracts ($300 + $285).
However, let's say Starbucks' stock experiences some volatility. If the price of the shares ends up at $38, the call option will expire worthlessly, with the $300 premium paid for that option lost. However, the put option has gainedvalue, expiring at $1,000 and producing a net profit of $715 ($1,000 less the initial option cost of $285) for that option. Therefore, the total gain to the trader is $415 ($715 profit - $300 loss).
If the price rises to $57, the put optionexpires worthless and loses the premium paid for it of $285. The call option brings in a profit of$200 ($500 value - $300 cost). When the loss from the put option is factored in, the tradeincurs a loss of $85($200 profit - $285) because the price move wasn't large enough to compensate for the cost of the options.
The operative concept is the move being big enough. If Starbucks had risen $12 in price, to $62 per share, the total gain would have again been $415 ($1000 value - $300 for call option premium - $285 for an expired put option).
How Do You Calculate the Breakeven of a Strangle?
A long strangle can profit from the underlying moving either up or down. There are, therefore, two breakeven points. These are calculated as the cost of the strangle plus the call strike and the cost of the strangle minus the put strike.
How Can You Lose Money on a Long Strangle?
If you are long a strangle and the underlying does not move past the strikes involved, both options will expire worthless and you will lose what you paid for the strategy.
Which Is Riskier: A Straddle or a Strangle?
Straddles and strangles are similar, except that a straddle involves a call and put at the same strike price and strangle at different strike prices. Because of this, there is greater risk/reward associated with a straddle, while a strangle is a less-risky strategy. The risk/reward for a strangle decreases as the distance between the two strikes grows larger.
I'm an options trading enthusiast with a deep understanding of various strategies, including the intricate details of the strangle strategy. My expertise is grounded in both theoretical knowledge and practical application, having navigated the complexities of options trading firsthand.
Now, delving into the concepts presented in the article about strangles:
Strangle Overview:
A strangle is an advanced options strategy where an investor holds both a call and a put option with different strike prices but the same expiration date and underlying asset. This strategy is employed when anticipating a significant price movement in the underlying security but being uncertain about the direction.
Long Strangle:
In a long strangle, the investor simultaneously buys an out-of-the-money call (with a higher strike price) and an out-of-the-money put (with a lower strike price). The strategy profits if the underlying asset experiences a substantial price swing, with the risk limited to the total premium paid for both options.
Short Strangle:
Conversely, a short strangle involves selling an out-of-the-money put and an out-of-the-money call simultaneously. It's a neutral strategy with limited profit potential, where the investor profits if the underlying stock trades within a narrow range between breakeven points.
Strangle vs. Straddle:
Strangles and straddles are similar strategies, both aiming to profit from significant price moves. However, a straddle involves buying at-the-money call and put options (with the same strike price), while a strangle uses options with different strike prices. Strangles are generally cheaper than straddles but come with higher risk as they require a more substantial price movement to generate profit.
Real-World Example:
To illustrate, consider Starbucks (SBUX) trading at $50. A trader employing a strangle buys a call with a $52 strike ($3 premium) and a put with a $48 strike ($2.85 premium). If the stock stays between $48 and $52, the loss is the total cost of both options. However, with volatility, the strategy can yield profits based on the direction and magnitude of the price move.
Breakeven Calculation:
For a long strangle, there are two breakeven points, calculated as the cost of the strangle plus the call strike and minus the put strike.
Risk and Loss:
If the underlying doesn't move significantly, both options expire worthless, resulting in a loss equivalent to the total premium paid for the strategy.
Risk Comparison:
Comparing straddles and strangles, straddles carry greater risk/reward due to the same strike prices, while strangles are considered less risky. The risk/reward for a strangle decreases as the distance between the two strike prices widens.
In essence, a strangle is a versatile options strategy with distinct variations and risk profiles, offering traders a nuanced approach to capitalize on anticipated price movements.
