What is Strangle options strategy?
A strangle is an options trading strategy designed to profit from significant price movements in a stock, regardless of direction. It involves buying (or selling) a call option with a strike price above the current market price and a put option with a strike price below the current market price. This setup benefits from large swings in the stock’s price, whether upward or downward
Differences Between Straddle & Strangle Option Strategies
Here’s how you can decide which is better in Long straddle vs. short straddle
Aspect
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Straddle
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Strangle
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Structure
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Involves buying or selling a call and a put option with the same strike price and expiration date.
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Involves buying or selling a call and a put option with different strike prices but the same expiration date.
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Cost
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Typically more expensive, as both options are at-the-money.
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Generally cheaper, as options are out-of-the-money.
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Profit Potential
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Higher profit potential, as at-the-money options react more strongly to price movement.
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Profit potential is slightly lower due to the out-of-the-money options.
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Risk
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For long straddle, risk is limited to premiums paid. For short straddle, risk is unlimited.
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Similar risk structure as straddle, but premiums are lower, reducing the upfront cost.
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When to Use
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When you expect a significant price movement in either direction with higher volatility.
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When you expect a significant price movement in either direction with moderate volatility.
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Example of straddle and strangle option strategies
Consider an Indian pharmaceutical company awaiting DCGI (Drug Controller General of India) approval for a new drug. Its stock price may witness significant volatility once the announcement is made.
A straddle strategy involves buying both a call and a put option with the same strike price and expiry date. For example, if the stock is trading at ₹500, you might buy a call and a put at the ₹500 strike with an expiry of, say, 25 July, paying ₹30 each. This strategy is ideal when you expect sharp movement in either direction. The total cost of the straddle would be ₹60. To potentially profit, the stock must move more than ₹60 (i.e., 12% of ₹500), either upward or downward.
Alternatively, a strangle involves buying a call and a put option with different strike prices but the same expiry date. Using the same example, you might buy a ₹540 call and a ₹460 put, paying ₹20 for each. For this strategy to be profitable, the stock must move beyond ₹580 or below ₹440—i.e., more than ₹40 away from either strike. Strangles, like straddles, are direction-neutral but also allow traders to lean slightly bullish or bearish depending on which leg they choose to weigh more heavily.
The risks of long straddle and strangle options strategies
Here is a look at the possible risks of long straddle and strangle options strategies:
- Time decay (Theta): Time decay causes options to lose value with each passing day. Your investment may be affected by this erosion, particularly if the expected price movement takes longer to materialise.
- Implied volatility (IV): Implied volatility fluctuations greatly affect option prices. Increased IV at the entrance point may cause premiums to rise, requiring significant price changes in order to break even.
- Directional uncertainty: Volatility, not direction, is what long straddles and strangles operate on. In the event that there is no noticeable movement in the stock, both options might expire worthless, leaving you with nothing.
- Transaction costs: The transaction costs associated with each trade affect your total profitability. These expenses pile up, especially if you switch entry and exit positions around a lot.
- Capital intensity: Long strangles and straddles tie up money that may be used elsewhere by necessitating premium payments upfront. Your capacity to successfully diversify your portfolio is hampered by this capital investment.
- Limited profit potential: Although there is theoretical potential for infinite profits, actual profits are frequently insufficient. Your profits may be limited by time decay and IV fluctuations, even if the stock moves significantly.
Straddles and strangles - The long and short of it
An options trader must have both straddles and strangles in their toolbox. These strategies, which include long straddles and strangles, provide alternatives for effectively dealing with market instability. The efficiency of these strategies is shown by their ability to profit from substantial price changes in shares, regardless of direction, whether one is anticipating product launches or earnings reports. Though each strategy has some inherent risk, it is important to exercise risk management. While strangles provide a low-risk entry point with increased risk exposure, straddles provide limitless profit possibilities. A complete understanding of options basics and an extensive grasp of market dynamics are essential for mastering these strategies.
Conclusion
Straddle and strangle strategies allow traders to benefit from sharp market movements in either direction. Straddles use at-the-money options, offering greater sensitivity to price shifts but at a higher cost. Strangles are more affordable, using out-of-the-money options, though they require larger movements to generate profit. The choice depends on volatility outlook, cost, and risk appetite. Straddles suit high-volatility environments, while strangles fit moderate ones. Traders should also consider time decay and changes in implied volatility. Ultimately, selecting the right strategy hinges on market conditions and individual goals.
