Key Takeaways
- Buy call and put with different strikes and same expiry.
- Long strangle profits from big price moves and volatility.
- Short strangle profits from stable prices and low volatility.
- Max loss limited in long; unlimited in short strangle.
What is Strangle?
A strangle is a neutral options strategy that involves simultaneously buying or selling a call and a put option on the same underlying asset with the same expiration date but different strike prices, usually both out-of-the-money (OTM). This setup aims to profit from significant price movements or stability, depending on whether it is a long or short strangle.
Long strangles benefit from increased volatility and large directional moves, while short strangles seek to profit from price stability and time decay.
Key Characteristics
Strangles have distinct features that set them apart from other options strategies:
- Strike Prices: Uses two different strikes—call strike above current price, put strike below.
- Types: Long strangle involves buying both options; short strangle involves selling both.
- Risk Profile: Long strangle has limited loss to premiums paid; short strangle faces potentially unlimited risk.
- Volatility Exposure: Long strangle benefits from volatility spikes; short strangle profits from volatility declines.
- Expiration: Both options share the same expiration date, emphasizing timing sensitivity and early exercise risk.
How It Works
In a long strangle, you buy an OTM call and an OTM put to capitalize on large price swings in either direction. The strategy requires the underlying asset to move beyond breakeven points, which include the strike prices adjusted for total premiums paid.
Conversely, a short strangle involves selling both options, aiming to collect premiums as income when the underlying remains within a defined price range. However, this exposes you to significant losses if the asset price breaks out, highlighting the tail risk associated with unexpected market moves.
Examples and Use Cases
Strangles are particularly useful around events that can create volatility or when you expect the market to trade sideways:
- Airlines: Traders might use strangles on stocks like Delta ahead of earnings announcements to capture sharp moves in either direction.
- Growth Stocks: Investors in volatile sectors often apply strangles to growth stocks to hedge or speculate on price swings.
- ETFs: New traders may explore strangles on diversified instruments such as those found in the best ETFs for beginners to manage risk with defined capital exposure.
Important Considerations
When implementing a strangle, carefully evaluate the cost of premiums and the impact of time decay, especially for long strangles where naked option exposure can increase losses. Additionally, consider implied volatility trends, as strangles are highly sensitive to changes in market expectations.
Always monitor your positions actively and be prepared to adjust or close trades to manage risk, particularly since short strangles carry theoretically unlimited losses if the underlying price moves sharply beyond the strike prices.
Final Words
A strangle offers a way to profit from expected volatility or stability, depending on whether you buy or sell the options. Evaluate your market outlook carefully and consider running scenarios to understand potential risks before implementing this strategy.
Frequently Asked Questions
A strangle is a neutral options strategy that involves buying or selling a call and a put option on the same underlying asset, with the same expiration date but different strike prices, usually both out-of-the-money. It aims to profit from significant price movements or price stability depending on the type of strangle used.
A long strangle involves buying an out-of-the-money call and an out-of-the-money put on the same asset. This strategy profits when the underlying asset makes a large move either up or down, benefiting from increased volatility and large price swings.
The key difference is that in a strangle, the call and put options have different strike prices, both typically out-of-the-money, while in a straddle, both options have the same strike price, usually at the current price of the underlying asset.
A short strangle is best used when you expect low volatility and the underlying asset's price to stay within a certain range. This strategy profits from the premiums collected by selling out-of-the-money call and put options and benefits from time decay if the price remains stable.
The main risk of a short strangle is potentially unlimited losses if the underlying asset moves sharply beyond the strike prices. Since you sell both call and put options, large price swings can force costly buybacks or delivery obligations.
For a long strangle, the breakeven points are the call strike price plus the total premium paid, and the put strike price minus the total premium paid. For a short strangle, the breakeven points are the call strike plus the net premium received and the put strike minus the net premium received.
Volatility is crucial in strangle strategies. Long strangles benefit from an increase in implied volatility, which can increase option premiums and potential profits. Conversely, short strangles profit from decreasing volatility, which helps the options expire worthless.
Sure! If a stock trades at $100, you might buy a $105 call and a $95 put, each costing $3. You pay a total of $6 in premiums, so for profit, the stock must move above $111 or below $89 before expiration to cover the cost and generate gains.
