In order to increase the chances of success in any financial market, an investor must spend time and patience to educate himself and learn more about the market. An essential step in this process is developing your own trading strategy that can help you fulfill your investment goals. In the world of options trading, this means first learning about essential strategies such as the strangle option strategy and then employing it in your investment.
So, what is the strangle strategy and how can it help your option investments in the long run? Here is an overview of the strangle strategy, its types, and how it is used by traders to maximize their investments.
What are Options?
Before we delve into the question of ‘what is a strangle’, let us first review the concept of options to better understand the context of strangle options. Options are a type of financial instrument known as ‘derivatives’ as their values are essentially derived from an underlying security. In terms of financial investment, an option is best defined as a form of contract that provides the buyer the right, but not the obligation, to sell or buy a given amount of an underlying asset at a predetermined price. This purchase or sale of the asset can take place only before the expiry of the options contract.
In order to understand the strangle option strategy, it is important to note here that this predetermined price in an options contract is known as the ‘strike price’. Moreover, an option that allows the investor to buy an asset is known as a ‘call option’ while the option that allows the selling of an asset is known as a ‘put option’.
Strangle Option Strategy Meaning
An options strangle is an investment tactic used to make gains based on predictions about substantial price fluctuations of a particular stock. This strategy involves buying or selling a call option with a strike price above the current market price of the stock and a put option with a strike price below the current market price.
How Strangle Strategy Works in Options Trading
Now that we have reviewed these essential concepts related to options, let us take a look at how they play into the strangle strategy. The strangle option strategy is employed by an investor when he holds a position in both a call option and a put option of the same underlying asset and with the same expiration date. However, these options are held at different strike prices.
As an investor, this allows you to benefit from the price movements of the underlying asset, no matter the direction in which the movement takes place. This strategy is beneficial if an options investor feels certain about the possibility of a sharp swing in an asset’s price but is uncertain about the direction.
Types of Strangle Strategy
As mentioned above, the strangle strategy is used by an investor to maximize his profits with an appropriate options investment. However, the exact form of strangle strategy used by an investor can vary across multiple strangle examples. Here are the two most commonly used strangle strategy examples as employed by options investors:
Long Strangle
One strangle option example is when the investor ‘goes long’ or buys both a call option and a put option of the same underlying security at different strike prices. The investor will make a profit in the event that the underlying price of the asset makes enough movement either above or below its current price. This means limited risk and in the event, the investor is correct, results in unlimited profit potential.
Short Strangle
In this more neutral strangle option strategy, the investor sells both the call and put options on the same underlying security, simultaneously. The strike price for the call must be above the current price while being lower than the current price for the put option. Short strangle strategies are typically associated with limited profit and unlimited risk. This type of strangle strategy is ideal for an investor who expects the underlying asset to experience very little volatility.
Benefits of Using the Options Strangle
Using the strangle option strategy has several benefits. Firstly, if the stock price experiences significant fluctuations, the profit potential from executing the call or put option increases proportionally. Moreover, since the stock price has no upper limit, the potential returns from the call option are also unlimited.
Secondly, if you become less confident that the stock price will fluctuate enough before the options expire or you want to lock in profits, reselling your options is an effective exit strategy. This allows you to realise profits before the options expire or minimise losses if the options have already lost value but are not yet worthless.
Lastly, the potential losses from using a strangle are limited to the amount paid for the options. This provides a rare combination of unlimited gain potential and limited risk, making the options strangle an attractive investment strategy for traders seeking to balance risk and reward.
Terminologies associated with the Strangle Options Strategy
A strangle option strategy is a strategy that involves buying or selling both a call option and a put option on the same asset, with the same expiration date but different strike prices. This allows investors to profit from significant price movements in the underlying asset, regardless of the direction.
A long strangle can yield profits when there is a dramatic price swing in the asset, while a short strangle can be profitable if the asset price remains within a specific range.
The strike price is the predetermined price at which the options contract is executed, while the spot price is the current price of the underlying asset.
If the asset price exceeds the strike price, the option is considered “in-the-money,” while an “out-of-the-money” option is one where the asset price is below the strike price. An “at-the-money” option is where the asset price is the same as the strike price.
A call option gives the buyer the right but not the obligation to purchase the underlying asset at an agreed-upon price and date, while a put option allows the buyer to sell the asset at the agreed-upon price and date.
The premium is the fee paid by the buyer to the seller of an option to participate in online trading.
Conclusion
As an investor in any financial market, it is essential to be aware of leading trading strategies such as the strangle strategy. In particular, if you are looking to invest in derivatives such as options, the strangle option strategy can prove beneficial when applied at the right opportunity. More often than not, strangle strategies require a substantial movement in asset prices in order to benefit the investor and also carry a higher risk than strategies such as the straddle strategy.
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FAQs
What is a strangle option strategy?
A strangle option strategy in India is a technique used by investors to benefit from significant price movements in the underlying asset, regardless of the direction. It involves purchasing or selling both a call option and a put option on the same asset, with the same expiration date but different strike prices.
How does a options strangle strategy work?
A strangle option strategy works by allowing investors to profit from significant price movements in the underlying asset, regardless of the direction. An investor can buy a call option and a put option on the same asset, with the same expiration date but different strike prices, to execute a long strangle. Alternatively, an investor can sell a call option and a put option on the same asset, with the same expiration date but different strike prices, to execute a short strangle.
What are the benefits of using a strangle option strategy?
The benefits of using a strangle option strategy in India include the potential to profit from significant price movements in the underlying asset, regardless of the direction. Additionally, this strategy provides investors with limited risk and unlimited reward potential, making it an attractive investment option.
What is the difference between a long and short strangle option strategy?
A long strangle option strategy involves buying both a call option and a put option on the same asset, with the same expiration date but different strike prices, to profit from significant price movements in the underlying asset. A short strangle option strategy involves selling both a call option and a put option on the same asset, with the same expiration date but different strike prices, to profit from the asset price remaining within a specific range.
What is the risk of using a strangle option strategy?
The risks of using an options strangle strategy include the potential loss of the premium paid to purchase the options if the asset price does not move significantly or moves in an unexpected direction.
