Strangle

What Is a Strangle?

Long strangle:

Buy 1 call
Buy 1 put

For a long strangle an investor buys 1 call option and 1 put option with different strike prices, but the same expiration month. This is simply a variation on the long straddle strategy. You're buying two options so you'll always pay a net debit to establish it. If you were to buy a call and a put that are currently out-of-the-money when the position is established, the strangle would cost less than a straddle. Strangles may commonly be purchased as a unit - i.e., 1 call and 1 put bought in a single transaction.

Why Use Strangles?

You feel strongly that the underlying stock will make a significant move within a certain amount of time, reflected by the expiration month you choose, but aren't sure in which direction. Though the strangle can cost you less upfront cash than a straddle, typically greater underlying stock moves are needed to profit. At the same time you might feel that time value levels are low and expect an increase in implied volatility to boost them.

Market Opinion of Long Strangles

This is considered a directionally neutral strategy.

You want the stock price to move significantly up or down, away from either strike price. You have no bias towards a bullish or bearish move so it's considered neutral with respect to direction.

Maximum profit potential of Long Strangles: substantial

Your maximum profit on the upside from the long call portion of this strategy is theoretically unlimited. On the downside, the long put portion provides substantial profits, limited only by the underlying stock declining to zero.

Loss potential: limited

Your potential maximum loss is limited to the net debit paid for the strangle. This will occur if the stock closes at or between the two strike prices at expiration.

Break-even point (B.E.P.) at expiration:

Upside B.E.P. = underlying stock price = call strike price + debit paid for the straddle
Downside B.E.P. = underlying stock price = put strike price - debit paid for the straddle

Possible Scenarios of Using Long Strangles

Positive Scenario of Long Strangles

The underlying stock makes a significant move up or down from either strike price. You hope that profit on one leg of the spread (i.e., the call or the put) will exceed the loss on the other. An increase in implied volatility would likely boost the market value of both your long options.

Negative Scenario of Long Strangles

The stock stabilizes between the two strike prices, implied volatility decreases, and time decay eats away at the value of both options.

How does Volatility impact of Long Strangles

An increase in implied volatility is a positive factor for this strategy; a decrease is a negative one.

Time Decay of Long Strangles

Time decay is a negative factor for this spread. You're long two options for each strangle you've established, so you'll experience time decay in both.

Example Strangle Trade:

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