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Long Strangle - Introduction
The Long Strangle, or simply the Strangle, is a volatile option trading strategy that profits when the stock goes up or down strongly. The Strangle is a cousin of the Long Straddle and the Long Gut, making up a family of basic volatile options strategies.
Learning the Straddle first makes the Strangle easy to understand.
Please Read About The Long Straddle Here.
The Strangle is in essence a technique used to place a Straddle at a cheaper price. The Strangle requires a lower debit amount to put on and works almost exactly like a Straddle.
Straddles, Strangles and Long Guts have their own pros and cons. Here's a comparison table:
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Straddle
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Strangle
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Long Gut
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Max Profit
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High
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Highest
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Low
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Max Loss
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Highest
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High
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Low
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Cost of Position
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High
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Low
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Highest
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Breakeven Points
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Narrow
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Wide
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Widest
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When To Use Strangle?
One should use a strangle when one is confident of a move in the underlying asset but is uncertain as to which direction it may be. Situations that creates an uncertainty as to the direction of move may be
just before an important corporate announcement, court verdict, earnings announcement etc...
How To Use Strangle?
Establishing a strangle simply involves the simultaneous purchase of an
out of the money (OTM) call option and an out of the money (OTM) put option on the underlying asset.
An out of the money
call option allows you unlimited profit to upside when the stock moves higher than the strike price with limited loss to down side. An out of the money
put option allows you unlimited profit to downside when the
underlying stock moves lower than the strike price with limited loss to upside. Combine them both and you will have a strangle which profits when the underlying stock moves up or down beyond the strike price of the respective options.
As the out of the money options in a Strangle is cheaper than the
at the money options in a Straddle, a Strangle is sometimes known as a "poor man's straddle".
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Example : Assuming QQQQ at $44. Buy To Open QQQQ Jan45Call, buy To Open QQQQ Jan43Put
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Trading Level Required For Long Strangle
A Level 2 options trading account that allows the buying of both call options and put options is needed for the Long Strangle. Read more about Options Account Trading Levels.
Profit Potential of Strangle :
This strategy profits in 2 ways. Firstly, if the stock goes up beyond the strike price of the Long call option, the Long call option goes up in price along with the stock price while the Long put option expires out of the money.
Secondly, if the stock goes down beyond the strike price of the Long put option, the Long put option goes up in price along with the drop in the stock price while the Long call option expires out of the money.
Profit Calculation of Strangle:
% Return = [Exit Price of Underlying Asset - (Strike Price + Net debit)*] ÷ Net Debit
* : If the underlying asset is down, use (Strike Price - Net debit)
Following up on the above example, assuming QQQQ closes at $50 at expiration.
Bought the JAN 45 Call for $0.80, Bought the JAN 43 Put for $0.75
% Return = [50 - (45 + 1.55)] ÷ 1.55 = 223% profit
Max. Risk = Net Debit = $1.55, if stock remains between $45 and $43.
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Risk / Reward of Strangle:
Maximum Profit: UnLimited
Maximum Loss: Limited
Net Debit Paid
Break Even Point of Strangle:
There are 2 break even points to a straddle. One breakeven point if the underlying asset goes up (Upper Breakeven), and one breakeven
point if the underlying asset goes down (Lower Breakeven).
Upper BEP: Strike Price + Net Debit Paid
Lower BEP: Strike Price - Net Debit Paid
Following up from the above example :
Upper Break Even = Strike Price + Net Debit = $45.00 + $1.55 = $46.55
Lower Break Even = Strike Price - Net Debit = $43.00 - $1.55 = $41.45
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Advantages Of Strangle :
:: Able to profit no matter if the underlying asset goes up or down.
:: Lower net debit than the Long Straddle strategy.
:: Higher profit in % than a straddle on the same move in the underlying stock, provided that breakeven point has been exceeded.
:: Since both options are OTM, price decay on the options is not as rapid as they are with the Long Straddle.
:: Unlimited profit if the underlying asset continues to move in one direction.
:: Saves time from having to analyse if a stock will go up or down ahead of major news releases.
:: Loss is limited to the debit paid.
:: If volatility is low at the time of purchase and volatility rises, both options could profit even without an appreciable change in the stock price.
:: No need to buy the underlying asset which is good for investors with small funds.
Disadvantages Of Strangle:
:: There will be more commissions involved than simply buying call or put options.
:: You can lose more money if the underlying asset stayed stagnant or within the breakeven range than if you simply bought a call or put option.
:: If the underlying asset rises above the strike price or falls below the strike price but remains below the upper break even or above the lower break even you will still incur a loss on the position.
:: If volatility falls for both or either option, the position could lose with or without a price swing in the underlying asset.
Adjustments for Strangles Before Expiration :
1. If the underlying asset has moved beyond its breakeven point and is expected to continue to move strongly in the same direction,
one could sell the out of the money option so that some value is recovered from it.
2. If one is very aggressive and confident that the underlying asset will continue to move strongly in the same direction, one could
then use the money gained from selling the out of the money option, and buying more contracts of the in the money option.
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