Unveiling the Strangle Strategy in Options Trading

Welcome to our comprehensive guide on the strangle options strategy. Whether you're a novice or an experienced trader, understanding the intricacies of the strangle strategy can help enhance your trading toolkit. In this guide, we'll explore what a strangle is, why it's used, how to implement it, and its pros and cons. Let's dive in.

What is a long strangle?

A long strangle is an options trading strategy that involves an investor buying a call and a put option with different strike prices but with the same underlying asset and the same expiration date. Unlike a straddle, which involves options at the same strike price, a strangle allows traders to potentially profit from significant price movements in the underlying asset, in either direction, without having to predict which way the market will move. It's an attractive strategy for traders expecting high volatility but uncertain about the direction of the price movement.

Why consider a strangle strategy?

Traders utilize the strangle strategy for a few reasons.

First, it offers potential for a profit in volatile markets. By purchasing both a call and a put option, traders can benefit from significant price movements regardless of direction.

Additionally, the strangle strategy can be more cost-effective than alternatives like the straddle, as it involves buying out-of-the-money options. A strangle's premiums are lower than a straddle strategy where you buy put and call at-the-money options, where their cost is higher because of their intrinsic value.

Strangles also offer flexibility and versatility as they allow traders to adjust their positions as market conditions change. This could involve closing one side of the position for a profit while letting the other side run, or selling both sides if the market moves favorably.

This potential for profit, lower cost when compared to a straddle, and flexibility make the strangle strategy an appealing choice for traders seeking to capitalize on market volatility.

Long strangle

A long strangle involves buying an out-of-the-money call option and an out-of-the-money put option simultaneously, with the same expiration date. The strategy aims to profit from significant price movements in the underlying stock, in either direction.

Profit/Loss Calculation

• Theoretical Maximum Potential Loss: Limited to the premiums paid for both options (total cost of the strangle) plus commissions.

• Theoretical Maximum Potential Gain: Unlimited on the upside if the stock price significantly rises; the call option gains value. Substantial profit potential on the downside if the stock price falls significantly, then the put option becomes valuable.

• Theoretical Maximum Proft Formula: Max(Stock Price - Call Strike Price) - Total Premium Paid,  (Put Strike Price - Stock Price)) - Total Premium Paid

Breakeven Points

• Upper Breakeven Point: Call Strike Price + Total Premium Paid

• Lower Breakeven Point: Put Strike Price - Total Premium Paid

Example

• Stock Price: $50 per share

• Call Option: Strike Price = $55, Premium = $2

• Put Option: Strike Price = $45, Premium = $1

• Trader buys both options for a total premium of $300 (100 shares per contract).

Potential Outcomes

• If the stock price rises above $58 or falls below $42 (includes the $3 premiums paid), the trader profits.

• Profit is determined by the difference between the stock price and the strike price of the profitable option(s), minus the total premium paid.

• If both options expire worthless (i.e., the stock price is between the strike prices at expiration), the trader realizes the maximum loss.

Short Strangle

A short strangle involves selling an out-of-the-money call option and an out-of-the-money put option simultaneously, with the same expiration date. This strategy aims to profit from minimal stock movement, time decay and decreased volatility, and for both options to expire worthless.

Profit/Loss Calculation

• Theoretical Maximum Potential Loss: Unlimited on the upside since the stock price in theory can rise indefinitely. On the downside, potential loss is substantial because the stock price can fall to zero.

• Theoretical Maximum Potential Gain: Limited to the premiums received for selling both options.

• Theoretical Maximum Profit Formula: Total Premium Received

Breakeven Points

• Upper Breakeven Point: Call Strike Price + Total Premium Received

• Lower Breakeven Point: Put Strike Price - Total Premium Received

Example

• Stock Price: $50 per share

• Call Option: Strike Price = $60, Premium = $2

• Put Option: Strike Price = $40, Premium = $2

• The trader sells both options for a total premium of $400 (100 shares per contract).

Potential Outcomes

• If the stock price remains between $40 and $60 until expiration, both options expire worthless, allowing the trader to keep the entire premium as profit.

• Losses may occur if the stock price moves beyond the breakeven points, resulting in one or both options being assigned and potential losses beyond the premiums received.

How to create a strangle strategy using moomoo

Moomoo provides a user-friendly platform for trading options. Here's a step-by-step guide:

Step 1: Go to your Watchlist, then select a stock's "Detailed Quotes" page.

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 2: Navigate to Options> Chain located at the top of the page.

Step 3: By default, all options with a specific expiration date are shown. For selective viewing of calls or puts, simply tap "Call/Put."

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 4: Adjust the expiration date by choosing your preferred date from the menu.

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 5: Easily distinguish between options: white denotes out-of-the-money, and blue indicates in-the-money. Swipe horizontally to access additional option details.

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 6: Explore various trading strategies at the screen's bottom, offering flexibility for your investment approach.

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Strangle vs Straddle: What are the differences?

Strangles and straddles are both volatility strategies, but they differ in their cost structure and risk-reward profiles. Let's start with a definition of both strategies.

A long straddle is an options strategy that involves buying both a call option and a put option with the same strike price and expiration date. It has no directional bias as the goal of a straddle is to profit from significant price movements in the underlying stock, regardless of the direction (up or down).

A long strangle also involves buying both a call option and a put option, but with different strike prices while keeping the same expiration date.

Here's a deeper comparison of these two options strategies.

Pros and cons of a strangle strategy

Pros

• Significant profit potential: Long strangles offer potentially substantial profit opportunities in volatile markets, allowing traders to benefit from significant price movements in either direction.

• Lower initial investment: Compared to straddles, strangles typically require a lower initial investment.

• Versatility: Strangles are adaptable to various market conditions and volatility levels, depending on which side of the trade you take. Long strangles are looking for volatility while short strangles are seeking minimal movement.

• Uncertain about price movements: The long strangle strategy enables traders to potentially profit from large price swings irrespective of the underlying asset's direction. This versatility makes it appealing for traders anticipating volatility but uncertain about price movements.

Cons

• Accuracy requirement: Successful strangle implementation in part hinges on accurately forecasting market volatility. Anticipating significant price movements can be challenging in unpredictable markets.

• Potential losses: While long strangles offer the potential for profit in volatile markets, there is also the risk of incurring losses. If the price movement is insufficient to cover the premium costs of both options, traders may experience losses. For short strangles, there's a risk for unlimited losses as there's an unlimited upside risk.

• Time decay: Long strangles are affected by time decay, particularly for out-of-the-money options. As expiration nears, option values may decline, affecting profitability

• Complexity: Strangles may pose challenges for novice traders due to their complexity. Understanding options pricing, volatility, and market dynamics is essential for effective execution.

In summary, strangles can offer substantial profit potential (on the buy side unlimited on the calls and substantial on the put side), while it's limited to the premiums received on the sell side.

As compared to a straddle, on the buy side, with the greater price moves on the underlying stock, comes greater potential profit; on the sell side, its limited to the premiums received but potentially unlimited losses with significant stock moves.

Traders should weigh these pros and cons carefully before incorporating strangles into their trading strategies.

FAQs about the long strangle strategy

When should you buy a strangle?

A strangle may be appropriate when anticipating high volatility but uncertain about the direction of price movement. It allows traders to potentially profit from significant price swings in either direction.

Is a strangle profitable?

Long strangles can be profitable in volatile markets with significant price movements. Success depends on accurately predicting volatility and timing trades effectively.

How important is implied volatility (IV) in strangles?

Implied volatility directly affects options premiums. Higher IV typically increases prices, potentially making strangles more expensive but more profitable (for someone long the strategy) if significant price movements occur.

Which is the safer strategy: straddles or strangles?

Neither straddle nor strangle can be considered inherently safer, as both involve risks. However, strangles typically have a lower initial investment, potentially making them appear less risky than straddles.