Getting familiar with all strategies can be tricky for a newbie entering the majestic world of options. Of course, previous experience in the trade market is very helpful, as options build their price on assets.
However, there’s much more than the asset’s price in options trading. The contract buyer has to consider the asset's previous and future movements, calculate the time decay, choose a strike, and speculate when the asset will move.
Therefore, options traders use various strategies, including options strategies strangle. In this article, we’ll discuss the strangle and how it works so that you can implement it in your options trading.
What Is Options Strangle?
Strangle is an options strategy that includes buying and selling calls and puts for the same asset simultaneously. The buyer holds two positions with different strike prices, but both the put and the call options are for the same underlying and have the same expiration date.
Unlike the similar options strategy straddle, strangle is considered to be safer and potentially more likely to make a profit. That’s because all contracts in the strangle have a different strike price, while the straddle includes calls and puts with the same strike price.
How Does Strangle Options Work?
Options strategies strangle works both for buying and selling contracts. Therefore, strangles can be long and short.
Long strangle
Long strangle strategy includes buying an out-of-the-money call and putting an option with the same expiration date on the same underlying asset that the buyer believes will experience a jump in price. Still, they’re not sure in which direction.
The long strangle is market neutral, meaning the buyer can profit whether the underlying moves up or down. Still, the price has to move beyond the break-even point for the call or the put to be profitable.
Long strangles are commonly-used strategies and can be implemented even by traders with a beginner strategy level. Strangles are favorable because the trader holds two positions, and the risk is limited.
If the underlying doesn’t exceed the break-even point, the net premium paid will be the maximum loss for the buyer. Conversely, the potential profit can be limitless.
Short strangle
Short strangles are also neutral strategies. They include selling OTM calls and putting options with the same expiration date on the same underlying asset that the seller believes won’t experience significant volatility.
Unlike the long strangle, the short strangle strategy is not recommended for beginners. It requires an advanced strategy level and a deep understanding of the market because it has an unlimited risk profile.
In a short strangle, the seller hopes that the underlying won’t move much, at least not beyond the break-even points. In that case, the maximum profit they can earn equals the premium amount.
On the other hand, if the underlying moves beyond the break-even points, the maximum loss is unlimited.
Long options strategies strangle example
Although reading definitions can definitely help explain what options strangles are, showing strangles through examples is the best learning method.
Let’s assume that there’s a stock currently trading at $100. You predict that the stock will experience high volatility in the next period. However, you’re not sure about the direction, that is, whether the stock will move up or down.
Therefore, you decide to implement the strangle strategy. You enter two long option positions. This means you buy both a call and a put for the same stock. Both options have the same expiration date.
You buy the call option for $3 with a strike price of $110. The premium for the put option is $2.50, and a strike price of $90.
Now, if by the end of the contract, the stock stays within the $90 - $110 frame, the options expire with no worth, and your loss equals the money you paid for the premiums. You’ll lose $2.50 + $3 = $5.5 per share.
Given that most options contracts give the right but no obligation to buy 100 shares of the underlying asset, in this scenario, you’ll lose $5.5 x 100 shares = $550. However, there are two other scenarios left.
Asset goes up
Let’s assume that the stock goes up to $120 over the option's life or on the expiration date. In this case, the put option you paid expires without worth. However, the call option is $7 profitable ($10 - $3 premium) per share.
You lost the premium of the put price, which was $2.50. Therefore, your profit will be $7 - $2.50 = $4.5 per share, or $450.
Asset goes down
If the stock goes down to $80, your call option expires without worth, and you’ll lose the $3 premium you paid. However, the put option has a $10 value. It gives a $7.5 profit ($10 - $2.5 premium).
Now, you need to cover the loss from the call option with the profit you gained from the put options - $7.5 profit - $3 call option premium = $4.5 per share, or a total of $450.
The Difference Between Strangle and Straddle Options Strategies
Options strategies strangle and straddle include simultaneously buying calls and puts. With strangle, traders assume the underlying will move and exceed a particular strike price. So, they buy out-of-the-money calls and put in different strikes with the same expiration date.
With straddles, the trader buys at-the-money calls and puts for the same underlying asset with the same strike price, expiring on the same date.
Is strangle or straddle better?
Both options trading strategies can be implemented by options beginners. Although there’s always a risk when it comes to options trading, strangle and straddle have a limited risk profile.
Whether you go for strangle or choose straddle, the maximum loss you can experience as a buyer is the net premium you paid. However, the potential profit is limitless, as the stock may jump beyond the strike price.
Of course, it’s the other way around for straddle and strangle sellers. For sellers, the maximum loss is unlimited. On the other hand, the only thing they can earn is the amount of the premium they sell.
Therefore, although strangles and straddles are commonly used, it’s recommended for beginners to stay on the buyer's side until gaining more experience.
What Is the Break-Even Point of a Strangle?
Each options contract has a break-even point. Since strangles include buying OTM calls and puts, they have two break-even points.
The calculations for call and put options are different. To calculate the break-even of a call, you have to sum the strike price and the premium. For puts, the break-even point is strike minus premium.
How Can You Set Up a Long Strangle?
Research and market analysis are the most crucial part of setting a strangle or any other options strategy. First, you have to find an asset, whether it is a stock, commodity, currency, etc.
If your research shows that the asset in question will experience significant volatility in the next period, that asset can be a suitable underlying for an options strategy.
You can set up options strategies strangle or straddle by buying OTM or ATM calls and puts for the same underlying with the same expiration date.
Now, finding the right asset and setting the right strike price for a strangle can be challenging. Therefore, many options traders use third-party services, like FoolProof Options, to get notified when there’s a movement on the market.
You can use FoolProof as an options-alert service because the platform is very cost-effective and offers a 14-day free trial.
So far, FoolProof has a spotless record of satisfied clients. That’s because it collaborates with experienced traders and market analysts who monitor the market constantly and inform their clients regarding all potentially profitable options.