Option Strategies – Strangles
A strangle is the variation of the option straddle. The strangles involves buying (or selling) an out-of-the-money call and an out-of-the-money put whereas the straddle involves buying (or selling) an at-the-money call and an at-the-money put.
Long Strangle
The following diagram shows a long strangle in which out-of-the-money calls and puts are bought. This strategy works best if the strike prices of the two options are close to equidistant from the current market price. The advantage of long strangle over long straddle is that the maximum loss is less. This is due to the fact that out-of-money options are cheaper to purchase. The disadvantage is that the price of the underlying asset must move further than it does under a straddle before a strangle position is profitable. The strangle is subject to the decay of time premiums. The sooner the price of the underlying asset moves after the long strangle is in position, the more like it is to be profitable.
Pay-off Diagram for Long Strangle
The call and put need not be bought at the same premium. The maximum lose is equal to the sum of two premiums.
Short Strangle
Short strangle is the opposite position to the long strangle. This strategy makes money if the market stagnates. However the potential loss can be unlimited.
The diagram below shows a short strangle, which is consist of selling an out-of-money put option and an out-of-money call option. Like the short straddle, if the price of the underlying asset suddenly moves up or down dramatically, the losses are theoretically unlimited. However, the price must move further than it does under a short straddle before losses are made. The trade-off is that the maximum profit of a short strangle is less than a short straddle.
Pay-off Diagram for Short Strangle
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Filed under All About Options, Option Trading Strategies by on Apr 16th, 2010. 