Options Strategy StrangleOften the most effective investment strategies are also the simplest one. This post will discuss one such simple but perhaps one of the most effective Options Trading Strategy: The Strangle. There are two types of strangle strategies depending on whether you buy options or sell options.
- Long Strangle: where you buy a Call and a Put Option on the same underlying with the same expiry date.
- Short Strangle: where you sell a Call and a Put Option on the same underlying with the same expiry date.
Options Strategies where you hold positions in more than one Options are commonly referred to Options Spreads.
Long Strangle SpreadIn a Long Strangle strategy is as explained below you buy both a Call and Put Option on the same underlying stock or index with the same expiry date. In my opinion, it is best to select out of the money Options when taking a position in Long strangle strategy. The above graph (courtesy - wikipedia) is a chart which plots profit earned by you on the expiry date of the Option against the price of the underlying at the expiry date. Notice that in a Long Strangle you make profit only if the price of the underlying moves beyond the strike price of any of the options by an amount greater than the total premium paid by you for buying the Options. In short - you make profit from a Long strangle only if the price varies a Lot.
- Long strangle strategy is best used when you expect a lot of variation in the price of the underlying. A scenario which makes Long Strangle an ideal Options strategy is when Stock markets are unstable - e.g. just before announcement of key financial data during a recession.
- The loss that can occur in a Long strangle spread is limited to the amount of premium that you pay to buy the Call and Put Options.
Short Strangle SpreadIn a Short Strangle strategy you write or sell a Call and Put Option (instead of buying). In other words you are short on the Options. Both the Call and Put Options have the same expiry date and are on the same underlying stock or index. In the discussion of Long Strangle you must have noticed that if the price of the underlying does not move much then the buyer of the Options is at a loss while the seller of the Options makes profit. Short Strangle is exactly the Options Strategy where you sell Call and Put Options instead of buying them.
- Short Strangle works best in stable markets where equities are fairly priced.
- Avoid entering a position in Short Strangle just before announcement of quarterly results or key financial data.
- The loss that can occur in a Short Strangle strategy is unlimited. Thus sometimes it maybe advisable to buy two deep out of the money Call and Put Options in a Short Strangle Strategy in order to limit your losses.
Delta Neutral Strangle StrategiesThis is simply the strategy where you choose your call and put option in such a way that their delta sums up to zero. In my opinion, when there is no obvious preferred direction for the market (i.e. upward and downward movements are both equally likely) then it is profitable to enter a Delta Neutral position. Read more about Delta Neutral Strategies.
StraddleAnother Options Strategy closely related to Strangle is Straddle. The only difference between Straddle and a Strangle is that in a Straddle the Call and the Put Options that you buy have the same strike price. Straddle strategy will be discussed in a later post.
Options Trading Strategies
Options Trading Basics