As the world of options trading grows and becomes more accessible, new investors must stay apprised of the various strategies that are used to make the most of market movements. One of the more common of these options trading strategies used by traders is the long strangle option strategy that benefits from substantial changes in asset prices. Read on to know more about this trading strategy, its many benefits as well as the things to keep in mind before employing it in your investments.
What is Options Trading?
The long strangle strategy works in the context of options trading, which is why it might be useful to first review the concept of options. Options are essentially financial instruments that derive their value from an underlying security. Hence, they fall under the category of derivatives.
Options are traded in the form of financial contracts whereby the buyer has the right but not an obligation to buy or sell the underlying asset at a given price known as strike price. However, as per options contracts, this trading can only take place before or on a predetermined date. The options that allow buying of assets are known as call options while those that allow selling of assets are known as put options.
How the Long Strangle Strategy Works Now that we are familiar with these concepts related to options trading, let us delve into the question of ‘what is a long strangle?’ as well as how this strategy is used.
In a long strangle strategy, an investor holds a position in a long, out-of-the-money call option as well as long, out-of-the-money put option of the same underlying asset. The two types of options are held with the same expiration date but at different strike prices. If there is volatility in the market, the investor profits from the substantial movements in price of the underlying assets. The long strangle option strategy is one of the types of strangle option strategy and aims at benefiting from the price movements of the underlying asset in options contracts. Long strangles are the more common forms of this strategy and are often employed in options trading.
Benefits of Long Strangle Strategy There are various long strangle examples that can be found in the world of options trading. This is because long strangle strategies are accompanied by certain specific benefits that set them apart from other strategies:
1. An investor benefits from a long strangle strategy if he feels certain that there will be volatility and sharp price movements in the market. However, the investor does not need to predict the direction in which this volatility will take place as the long strangle accounts for both upward and downward movements of price.
2. The risk potential for long strangle strategy is limited and occurs only when the price remains between the strike prices for the put and call options. Also, the maximum loss for this strategy only amounts to the net premiums paid.
3. The profit potential for the long strangle options, on the other hand, is unlimited. Whether the price of the underlying asset moves in an upward or downward direction, the profit can be earned and calculated by subtracting the strike price from the stock price.
4. Long strangle options are much less expensive than other options strategies. This is because the strategy calls for out-of-the-money options, the premiums of which are cheaper than at-the-money options.
Note to Keep in Mind for Long Strangle Now that we are familiar with the long strangle option strategy and its benefits, it might be worth keeping in mind a few pointers about employing this strategy. The long strangle strategy is more time-sensitive than other strategies and subject to time decay. It is recommended to enter a long strangle position with about 3 months to the expiration of the contracts and exit 1 month before expiration.
In the world of options trading, the long strangle strategy makes frequent appearances and can prove useful for investors looking to make the most of market volatility. As a low-cost strategy with limited risk and unlimited profit potential, long strangle is ideal for market movements related to current news and events. However, the process of entering and exiting a long strangle position must be carried out with the necessary caution so as to minimize risk and loss to the investor.