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Purpose Of Strangle
1. To Profit When A Stock Goes Up Or Down
2. To Reduce Cost Outlay Versus A Straddle
Expectations Of Strangle
Volatile
Type Of Spread
Debit Spread
How To Use Strangle?
Buy an Out Of The Money (OTM) call option and an OTM put option on the underlying stock at the same expiration month.
Buy OTM Call + Buy OTM Put
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Profit Potential of Strangle :
The Strangle profits when the underlying rallies above or ditches below the upper / lower breakeven point.
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)
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
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.
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