What is the Strangle Strategy?

A strangle is an options strategy with a call and a put option with different strike prices. However, these two options have the same expiration date and underlying asset. If a trader feels that there will be a large price movement in the days to come, but is not sure of which direction it will move in, then this is a good strategy to opt for. Similar to a straddle, its difference lies in the fact that it uses options at different strike prices.

Long Strangle

A long strangle will benefit an investor if the price change of the underlying stock experiences a big change, whatever the direction of it may be.?

Profit/Loss

The profit potential of a strangle is unlimited (if it is on the upside because then the stock price can rise indefinitely) or substantial (if it is on the downside because then the stock price reaches the zero level).?

The potential loss that may be experienced, though, is limited to the total cost of the strangle (including the commissions). This happens when the position is held to expiration and the stock price is equal to/ between the strike prices at expiration, thus making them worthless.

When to Choose This Strategy?

• When the price of the underlying stock goes above the upper breakeven point or if it goes below the lower breakeven point, then the long strangle will show profits.?
• The risk associated with this strategy is that if the stock price does not change considerably, then the call and put prices both decrease, and then traders then sell both options.
• When the chances of volatility increase, it means that higher prices have to be paid for buying options. This, for strangles, means that the breakeven points are farther apart. Hence, the movement of the underlying stock price will be more so as to reach the breakeven point.?
• As long strangles have two long options, it is more sensitive to time erosions. Thus, it tends to make losses quickly over time.

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What Happens at Expiration?

Three outcomes are at expiration.?

• The stock price is at/between the strike prices – Both the call and the put expire worthless?
• The stock price is above the strike price of the call – Put expires worthless, the long call is exercises, the stock is purchased at the strike price?
• The stock price is below the strike price of the put – Call expires worthless, the long put is exercised, the stock is sold at the strike price?

Short Strangle

An investor can profit from a short strangle if the underlying stock experiences little or no price movement. It consists of a short call and a short put. The former has a higher strike price and the latter has a lower strike price. Both, though, have the same underlying stock and the same expiration date.?

Profit/Loss

The profit that one can earn is the total premium that is received less the expense of commissions. The short strangle earns maximum profit if it is held to expiration and if the stock price closes at/between the strike prices, thus making both options worthless.

In this strategy, the potential loss is unlimited (if the stock price rises because then it can rise indefinitely) or substantial (if the stock price falls because then, at most, it can fall to zero).

When to Choose This Strategy?

• When the underlying stock’s price fluctuates in a narrow range between the breakeven points then an investor will benefit from holding a short strangle.
• When volatility increases, so do the price of the options. Thus, when this happens the price of short strangles goes up and there is financial loss.?
• Short strangles are sensitive to time. This means that one can make quick money with time.?

What Happens at Expiration?

Three outcomes are at expiration.?

• Stock price is at/between the strike prices – Both the call and the put expire worthless?
• Stock price is above the strike price of the call – Put expires worthless, the short call is assigned, and stock is sold at the strike price?
• Stock price is below the strike price of the put – Call expires worthless, the short put is assigned, the stock is purchased at the strike price?

Short Strangle Adjustments

The aim of a short strangle is to bring down the risk by selling off two options – when the underlying stock moves in one direction, while one option loses, the other goes on to gain. However, while selling a short strangle can generate income, it comes with risks. If not managed correctly, it can lead to significant financial losses. Hence, the need for adjustments.?

Adjustments are generally made slowly with this strategy. With this in mind, if a trader finds that the stock is quickly moving towards one end of the strategy, then he will make adjustments on the side that the stock is moving away from. This is done by moving that option closer to the money. Doing the reverse, which is moving up the side that the stock is moving towards, only increases the chances of compounding losses (this will happen if the movement continues to stay in this direction).

The question that arises is how much adjustment is correct.?

• The correction should be such that the probability on the side where adjustments are being made is reset to what it was when the strategy came into play.?
• The adjustments should be made so that the number of call and put options on either side should remain the same as it was in the beginning.?