Strangle Option Strategy
Strangle option strategy is an investment strategy that is poorly understood by most investors. Most novices into option trading don’t know of its existence or how to properly utilize it to their profit. We will try to explain this strategy in simplest possible terms because once you understand how you can be using strangle strategy, it will help you tremendously in your future trades.
What is Strangle Strategy?
Strangle is an option strategy that allows investor to take a trade in both a “call” and “put” direction with different strike prices but have the same expiry date and potential profits. When you purchase an option, it is known as a long strangle while selling of the same options is called short strangle. Strangle must not be confused with straddle, the main difference between the two is that strangle gives the investor an option of balancing cost of opening the trade with probability of profit. Strangle are also less expensive than a straddle since the contracts are bought out-of-the-money.
Strangle option strategy involves two steps to trade:
- Buying an out-of-money Put option
- Buying an out-of-money Call option
When Can You Use Strangle Strategy on Binary Options?
Strangle is a very good option strategy but it should be used with utmost caution. Most investors use strangle option strategy when they think there are going to be a big price movement (influence mostly by news) but they aren’t sure which direction the price will go when it breaks out.
During earnings season you may anticipate a major move coming very soon but you cannot say exactly at which direction the move will go. Because of the anticipation of a good earnings report, the price of a stock may be going up, however when the report is finally released, the stock may reverse or in some cases fizzle out since the value of good earnings have already been absorbed by the anticipation.
The best time to use strangle option strategy is when companies are reporting their quarterly earnings. Also newsworthy reports which affects stock provides an opportunity to use strangle strategy. Buy when volatility is low and sell as the volatility picks up pace before the news or as soon as the news is over.
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Example of A Strangle Options Trade
Lets show an example of strangle trade with the example below:
Lets assume that the stock of NASDAQ is trading at $20 per share. A trader wants to employ strangle options strategy, as such he enters his trade in the 2 option positions i.e. One call trade and one put trade. Assuming the call is for $25 and cost $200 (which is $2 per option times and 100 shares) his put for the same NASDAQ shares is for $15 and costs $185 (which is $1.85 per option times 100 shares). If the price of the stock does not move from the range of $15 and $25 until the expiry of the trade, the trader will lose $385 which is the total cost of the both option contracts. Should the price of the stock move out of this range, the trader will make money. Assuming that the price of this stock ends up at $10, it means that the call option is now worthless and the trader will lose $200 (which is the cost of the call) But the put option have gained a lot of profit for the trader, its worth now is about $815 (which is $1000 $185, the initial put value). The total gain the trader made from the trade is now $615.
Risk and Rewards for Using Strangle Option Strategy
When using strangle options strategy the maximum risk an investor assumes is equal to the net debit of the amount paid for the 2 option contracts. In a situation where the stock does move anywhere, the trader loses. The reward for using this strategy is unlimited for both the call and put options.
Benefits Of Using Strangle Option Strategy:
- There is opportunity to make money from both directions
- The traders loss is limited only to his cost of position
- It is less expensive than long straddle.