Modules for Traders
Trading Strategies 1
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Understanding and using the Strangle
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 into 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 maximise their investments.
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 maximise 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:
1. 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, result in unlimited profit potential.
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:
- 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.
- 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.
- The profit potential for the long strangle options, on the other hand, is unlimited. Whether the price of the underlying asset moves in upward or downward direction, the profit can be earned and calculated by subtracting the strike price from the stock price.
- 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.
2. 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.
Tips for Short Strangle Strategy
With the unlimited risk potential that accompanies the short strangle option strategy, it is important for an options investor to keep in mind certain considerations before taking the position:
– The short strangle option strategy is ideal for circumstances where the market forecast is fairly neutral and there is only possibility for limited action in the market. For example, an appropriate opportunity for the short strangle is the intermediary period between major events or announcements that are certain to cause major price fluctuations.
– Another good opportunity for the short strangle strategy is when the trader feels that the options are overvalued and the predicted volatility seems on the higher end. It gives the investor a chance to profit from the price correction.
– The investor should also ensure that the time frame to the expiration date remains short, with 1 month being the maximum, to make the most of time decay.
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 higher risk than strategies such as the straddle strategy.
A quick recap
- A strangle is a popular options strategy that involves holding both a call and a put on the same underlying asset.
- A strangle covers investors who think an asset will move dramatically but are unsure of the direction.
- A strangle is profitable only if the underlying asset does swing sharply in price.