Options strategy - Strangles
A strangle is an options trading strategy that involves buying both a call option and a put option on the same underlying asset, but with different strike prices and the same expiration date. The goal of a strangle is to profit from a significant price movement in the underlying asset, regardless of its direction.
Here's how a strangle works:
Identify the underlying asset: Choose the stock, index, or any other financial instrument on which you want to execute the strategy.
Determine the strike prices: Select a higher strike price for the call option and a lower strike price for the put option. The distance between the two strike prices should reflect your desired range for the underlying asset's price movement.
Buy the call option: Purchase a call option with the higher strike price and the chosen expiration date. This gives you the right to buy the underlying asset at the strike price.
Buy the put option: Simultaneously purchase a put option with the lower strike price and the same expiration date. This gives you the right to sell the underlying asset at the strike price.
Execute the trade: Buy both the call option and the put option simultaneously. This will result in a net debit, as you will pay the premiums for both options.
Profit and loss potential: The strangle has an unlimited profit potential on the upside and downside, and a limited loss potential. The maximum profit is achieved if the price of the underlying asset significantly exceeds the higher strike price or falls well below the lower strike price at expiration. The maximum loss occurs if the price of the underlying asset remains between the two strike prices at expiration. The total premium paid for both options is the maximum potential loss.
The strangle strategy is typically employed when there is an expectation of high volatility or an anticipated significant event that could cause a sharp price move in the underlying asset. It allows the trader to profit from a large move in either direction, while limiting the potential loss to the premium paid. Traders should consider factors like implied volatility, time decay, and the potential impact of the price move on the breakeven points before employing a strangle strategy. Managing and adjusting the position may be necessary as the market evolves.
The maximum profit for a strangle is unlimited. This is because the investor will profit if the stock price goes up or down, as long as it moves by more than the difference between the strike prices, minus the cost of the options.
The maximum loss for a strangle is limited to the cost of the options. This is because the investor will lose money if the stock price stays within the range of the strike prices at expiration.
The break-even points for a strangle are:
Long call break-even: Strike price + Cost of options
Short put break-even: Strike price - Cost of options
This means that if the stock price is at either of the strike prices at expiration, the investor will break even.
Strangles are a relatively lower-risk options strategy than straddles, but they can still be profitable if the underlying asset price moves significantly.
Here are some of the pros and cons of strangles:
Pros:
Limited risk
Can be used to profit from a large move in the price of the underlying asset
Cons:
Not as profitable as straddles
Requires a large investment
Can be complex to understand
If you are considering using a strangle, it is important to understand the risks involved and to make sure that it is a suitable strategy for your investment goals.
Here are some additional things to keep in mind about strangles:
The profit potential of a strangle is unlimited.
The maximum loss of a strangle is limited to the cost of the options.
The break-even points of a strangle are different for the call and put options.
Strangles are most profitable when the underlying asset price moves significantly in either direction.
Strangles can be used to profit from a large move in the price of the underlying asset, but they can also be risky.
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