What is a Strangle Options Strategy?
A strangle is an options position that holds an out-of-the-money call and an out-of-the-money put on the same underlying with the same expiration. A long strangle (buying both) profits if the stock moves far enough in either direction to pass a breakeven: the call strike plus the total premium, or the put strike minus the total premium. The maximum loss is the premium paid, which happens if the stock ends between the two strikes. A short strangle (selling both) is the reverse: it keeps the premium if the stock stays between the strikes but has unlimited risk on the upside. This article is educational, not investment advice.
Strategies for Strangle Options
A long strangle is direction-neutral: it is used when a trader expects a large move but does not know which way, for example before earnings. A short strangle is used when a trader expects the underlying to stay in a range and implied volatility to fall.
Overview of Strangle Option Trading
The strangle option strategy is typically used by more experienced traders, as the strategy carries a higher degree of risk. As with any type of trading, it is important to have a clear understanding of the option’s terms, including the strike price and time to expiration, which may dictate when the option can be exercised. It is also important to understand the difference between a put and a call option. A put option gives the buyer the right to sell the underlying at a predetermined price on or before the expiration date, while a call option gives the buyer the right to buy the underlying at a predetermined price on or before the expiration date.
Advantages of Strangle Option Strategies
The main objective of a strangle option strategy is to benefit from large price movements that occur in either direction. This type of option strategy allows traders to benefit from increases and decreases in the underlying asset’s price without having to predict the direction of the move.
A long strangle also costs less than a straddle, because both options are out of the money and so have lower premiums. The trade-off is that the stock must move further before the position profits.
Risk Management with Strangles
It’s important for option traders to use risk management techniques when employing strangle strategies. A common risk management method used by traders is to close out one of the options as soon as a profit is realized or to place protective stops. Also, it’s important to be aware of the time-value decay of the options and adjust the strategy as this occurs.
How to Design a Strangle Trade
When designing a strangle trade, traders typically purchase call and put options with different strike prices. For example, with the stock at $45 a trader may buy a $50 call and a $40 put for a combined $2.00. The maximum loss of $2.00 ($200 per contract pair) occurs if the stock finishes between $40 and $50 at expiration. The breakevens are $52 and $38; profit grows as the stock moves beyond either one.
Steps of Setting Up a Strangle
Step 1: Identify the underlying asset and determine the strike prices for the options.
Step 2: Choose the option expiry date and potential payoff scenario.
Step 3: Evaluate the potential risk and rewards of the trade.
Step 4: Place an order for the option, depending on the chosen strategy.
Step 5: Execute the trade and monitor the price of the underlying asset.
Step 6: Close out the trade or adjust it if necessary.
When to Use a Strangle Option
Long strangles are typically used when traders expect a large price move in either direction. Short strangles are used when the trader expects the underlying to remain in a range over a certain period of time.
Pros and Cons of Strangle Options
The main advantages of a long strangle are profit from large moves in either direction, a lower cost than a straddle, and a maximum loss capped at the premium. The disadvantages are that the stock must move past a breakeven before expiry, and time decay erodes both options. A short strangle, by contrast, can lose far more than the premium collected. It is also important to consider the cost of premiums and potential time-value decay when entering a strangle trade.
Profit Potential of Strangle Options
The profit potential of a long strangle is unlimited on the upside and large on the downside (down to a stock price of zero), but only once the stock moves past a breakeven. If the underlying finishes between the two strikes at expiration, the long strangle loses its full premium; that outcome is where a short strangle earns its maximum profit.
Here are some templates that you can use to create your own models
Long Strangle Option Strategy
Calendar Strangle
Strap Strangle
Strip Strangle
Calendar Straddle
Short Albatross Spread
Search for all templates at MarketXLS templates.
Relevant blogs that you can read to learn more about the topic
Strap Strangle Options Strategy (Using MarketXLS Template)
Strip Strangle Options Strategy (Using MarketXLS Template)
Exploring the Risk/Reward of Strangle Options Trading
Short Guts Options Strategy