Strangle option trading strategy

Note: Long strangles are always traded out-of-the-money OTM. If the long strangle is traded at-the-money, ATM it would be considered a long straddle. The best case scenario this example trade is for XYZ to fly to the moon, or crash and burn to the ground. Hence, dramatic moves are often needed for this strategy to be profitable. The maximum profit for a long strangle is always theoretically unlimited on the upside and capped at the underling going to zero on the downside.

The long strangle option strategy is truly a neutral strategy, but there is an important distinction to make. Although this is considered a neutral strategy, dramatic moves, either up or down, are needed for the long strangle to work. If the bottom falls out of the underlying asset, the position will make money. If the underlying asset crashes up, the position will also make money. Therefore, the primary reason why traders buy strangles is to speculate that there will either be a dramatic increase in volatility or a dramatic move in the underlying asset, or both.

Theta decay is very detrimental to a long strangle, because there are two long options positions. As expiration approaches, the long call and long put components of a long strangle are going to decrease in value solely due to time premium decay.

Long Strangle Summary

It almost goes without saying that timing is critical for making money with long strangles. As with all long options, if the value approaches zero, the best practice is to leave the position untouched, because there is always the chance that something will happen in the underlying and the position will become profitable; a long option position can never be worth below zero. You can sell slightly higher calls that are likely to expire worthless so that the premiums become your income.

There are two kinds of price movements you need to be wary of. As long as the stock is stagnating around the current levels or up to the higher call strike price, you have nothing to worry about because you will earn the premium.

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If the price shoots above the strike price, then the losses on the sold call can be unlimited. But that is fully covered by your long stock position. However, on the downside, your risk is fully open and you need to be wary of that. Illustration 2: An investor buys a stock in the cash market at Rs.

In the covered call strategy we saw that the downside risk was open. Essentially, the collar combines a protective put strategy and a covered call strategy. Here there are 3 phases to the strategy. First, you are long on the stock. Secondly, you buy a lower put option. Thirdly, you sell a higher call option. How does this help? In the covered call strategy, the downside risk was open. Now that risk is closed by buying a lower put option. In the protective put strategy, at times the cost of buying put option may be too high. By selling a higher call option, the premium received can partially compensate for the premium paid on the put option.

The beauty of the collar strategy is that it is a limited loss and limited profit strategy. Such strategies are called closed option strategies.

Limited Profit

Illustration 3: An investor buys a stock in the cash market at Rs. He also buys Rs. Here is the payoff. In a nutshell, protective puts are bullish strategy that comes with protection on the downside. Covered calls are used to reduce the cost of holding the stock but come without downside protection.

When you combine the protective put and the covered call, you have the collar which is a closed strategy with limits on losses on the downside and profits on the upside. Option strategies are fine when you have a view on the direction of the market. What if your only view is that the index or the stock is going to either become more volatile or less volatile?

In such circumstances, you can use strategies like the straddles and strangles. The straddle strategy involves two options of same strike prices and same maturity. A long straddle position is created by buying a call and a put option of same strike and same expiry whereas a short straddle is created by selling a call and a put option of same strike and same expiry.

A long straddle is a volatile strategy that is intended to be profitable when the stock is highly volatile and shows a sharp movement either on the upside or on the downside. Illustration 4 : A trader expects the stock of TCS to become volatile in the next 15 days but is not sure of the direction. The stock is currently quoting at Rs. Now look at the pay off.

The strangle strategy involves two options of different strike prices and same maturity.

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• Long strangle.

A long strangle position is created by buying a higher strike call and a lower strike put option of same expiry whereas a short strangle is created by selling a higher strike call and a lower strike put option of same expiry. A long strangle is a volatile strategy that is intended to be profitable when the stock is highly volatile and shows a sharp movement either on the upside or on the downside.

The advantage of the Strangle over the straddle is that it lowers the cost of the buyer of the Strangle and expands the range of profitability for the seller of the Strangle. That is the reason, strangles are a lot more popular in practice compared to a straddle. Illustration 5 : A trader expects the stock of TCS to become volatile in the next 15 days but is not sure of the direction. Just as the collar is an extension of covered call, the butterfly spread is an extension of short straddle.

You will recollect that downside risk in short straddle is unlimited if market moves significantly in either direction up or down. To put a limit to this downside, along with short straddle, trader buys one out of the money call and one out of the money put. The butterfly spread is a closed strategy but you need to remember that there are 4 legs to initiation of the Butterfly Spread and 4 legs to closure. That will significantly add to the costs of the strategy, when you consider the transaction and statutory costs. Hence butterfly spread is used sparingly by traders. We have seen directional strategies, volatile strategies and we have also seen range bound strategies.

In the last section we shall look at spread strategies. That sounds complicated but actually it is quite simple.

Long Strangle | Daniels Trading

In a nutshell, these spread trades are about limited profit and limited loss positions. Broadly, such spreads are categorized into three sections as:. Vertical spreads are created by using options having same expiry but different strike prices. Further, these can be created either using calls as combination or puts as combination. Also, such vertical spread can be bullish vertical spreads or bearish vertical spreads.

Short strangle

Bull call spreads and bear put spreads are two of the most popular vertical spreads and we shall dwell in these two strategies in greater detail later. Horizontal spread involves same strike, same type but different expiry options. For example, buying a Nifty 11, August call and selling an 11, September is an example of horizontal spread.

This is also known as time spread or calendar spread. It is not possible to draw the pay off chart as the expiries underlying the spread are different.

Short Strangle

The profit potential is unlimited, while the risk is limited to the net premium paid in this strategy. The maximum loss is reached when the stock price falls between point A and point B on expiration. A trader who enters the long strangle options strategy is banking on significant movement in the stock, either upwards or downwards, by the expiration date.

If the stock trades up, there is no limit to how far it can go and how much profit can be made. If the stock trades down, the trader can make profits all the way down to zero. Traders have limited risk when executing a long strangle options strategy as they are capped by the premium paid to enter the trade.

Whether the market is up, down, or sideways, the Option Strategies Insider membership gives traders the power to consistently beat any market. Spend less than one hour a week and do the same.

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New traders are often attracted to the long strangle option strategy due to the possibility of massive gains accompanied by limited risk. However, the long strangle option strategy comes with a very low probability of success as a trader must pay two premiums, both on the call side and the put side, and then expect the stock movement after the position is entered to travel far enough to account for both premiums paid.