We try different types of approaches in the stock market to maximize our profits. Strangle in options is also one of the techniques to improve your profits. Let’s discuss what is a strangle in options in detail with examples to understand it properly.
What is a Strangle in Options?
A strangle is an options strategy in which the trader buys a call and a put option with separate strike prices but the same expiry date and actual stock.
If you believe the actual asset will undergo a major price fluctuation in the near future but are uncertain of the direction, a strangle is a suitable strategy to use. Nevertheless, it is only effective if the asset’s price swings dramatically.
A strangle is similar to a straddle, but instead of using a call and put at the same strike price, it involves options with separate strike rates.
Things to Keep in Mind
- A strangle is a common options strategy in which a call and a put on the same basic asset are held simultaneously.
- A strangle is for traders who believe an instrument will move drastically but aren’t sure which way it will go.
- A strangle is successful only if the actual asset’s price fluctuates significantly.
Consider the case of Starbucks (SBUX), which is now trading at $50 per stock. A trader uses the strangle option technique by taking two long option positions, one call and one put.
The call has a $52 strike price and a $3 premium, totaling $300 ($3 x 100 shares). The strike price of the put option is $48, and the premium is $2.85, totaling $285 ($2.85 x 100 shares). The expiry dates for both alternatives are the same.
If the stock price maintains between $48 and $52 for the duration of the option, the trader will lose $585, which is equal to the overall cost of the 2 option contracts ($300 + $285).
Let’s imagine, on the other hand, Starbucks‘ stock is volatile. If the stock price reaches $38, the call option will expire useless, and the $300 premium paid for it will be forfeited.
The put option, on the other hand, has gained value, expiring at $1,000 and yielding a net profit of $715. As a result, the trader has made a total profit of $415.
The put option expires useless if the price climbs to $57, and the $285 premium paid for it is lost. The call option generates a $200 profit.
When the loss from the put option is taken into account, the trade loses $85 ($200 profit – $285) since the price change was insufficient to cover the cost of the options.
The key principle is that the move must be large enough. If Starbucks’ stock had increased $12 to $62 per share, the overall gain would have been $415 ($1000 value minus $300 call option premium minus $285 for an expired put option).
Types of Strangles
There are two kinds of strangles Long strangle and short strangle:
A long strangle is a method in which an investor buys both an out-of-the-money call and an out-of-the-money put option at the same time.
The strike price of the call option is greater than the present market price of the actual instrument, while the strike price of the put option is lower.
So because call option has theoretically unlimited upside if the actual asset grows in price, and the put option can benefit if the underlying asset decreases in price, this approach has a high profit potential.
The trade’s risk is limited to the difference between the two options’ premiums.
A short strangle is when a trader sells both an out-of-the-money put and an out-of-the-money call at the same time. This is a profit-limited strategy with a neutral attitude.
When the value of the actual stock trades in a small range between the breakeven points, a short strangle makes money.
The maximum profit is equal to the difference between the net premiums collected for writing the two options and the trading fees.
Advantages & Disadvantages of Strangles
|S.no||Advantages of Strangles||Disadvantages of Strangles|
|1.||Gains from a price movement in either way for an asset.||Needs a significant price movement in the asset.|
|2.||Less expensive than other options techniques, such as straddles.||May be more risky than other techniques.|
|3.||Profit potential is limitless.|
Difference between Strangles and Straddles
Strangles and straddles are two options techniques that allow investors to profit from big upward or downward price movements.
In contrast to out-of-the-money options, a long straddle entails concurrently buying at the money call and put options with strike prices that are similar to the underlying asset’s market price.
A short straddle is similar to a short strangle in that it has a limited profit potential equal to the premium earned by selling at-the-money call and put options.
The trader earns from the straddle when the price of the security rises or decreases by an amount more than the entire cost of the premium from the strike price. As a result, there isn’t as much of a pricing difference.
Purchasing a strangle is less expensive than purchasing a straddle, but it entails more risk because the underlying asset must make a larger move to achieve a profit.
Trading options is simple yet very quite complex for beginners in the stock market. You must do your risk assessments before trading options.
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Frequently Asked Questions
How does a strangle option work?
A strangle is an option strategy in which you hold both a call and a put on the same basic asset. Investors who believe an asset will move drastically but are unsure of the direction might consider a strangle. Only if the underlying asset's price swings drastically is a strangle lucrative.
What is a strangle option example?
Purchasing a call with a higher strike price and a put with a lower strike price makes up a long strangle. Purchase a 105 Call and a 95 Put, for instance. Long straddles, on the other hand, entail purchasing both a call and a put with the same strike price. Buy a 100 Call and a 100 Put, for instance.
When would you buy a strangle option?
Another approach to options is the strangle position. While a straddle has no directional bias, a strangle is used when the investor believes the stock has a better chance of moving in a certain direction, but would still like to be protected in the case of a negative move.
How does a strangle make money?
A strangle is an options strategy in which you buy (sell) an out-of-the-money call and a put in the same basic and expiry. A short strangle pays out if the underlying doesn't move much, and it's suitable for traders who expect minimal volatility.
Why strangle is cheaper than straddle?
A straddle requires you to purchase both call and put options on the ATM strike. The strangle, on the other hand, necessitates the purchase of OTM call and put options. Remember that the OTM strike is usually less than the ATM strike, consequently setting up a strangle is less expensive than setting up a straddle.