Options Strategy – Understanding the Strangle

Home/Investments/Options/Options Strategy – Understanding the Strangle

Options Strategy – Understanding the Strangle

It has been over a month since I taught myself a new options strategy.  Unacceptable.  This year I have researched and written about bull put spreads and the straddle.  I have implemented the bull put spread, but have yet to implement a straddle.  Well, next on my list the strangle.

If you are brand new to options, or do not have the basics down you are going to want to check out my basic post on the call and put.

What is a Strangle Options Contract?

A strangle options contract is when you buy/sell a call and a put with the same expiration date, but not the same strike.  If the two contracts were at the same strike price it would be a straddle.

Going Long on a Strangle Options Contract

From Wikipedia,

The long strangle involves going long (buying) both a call option and a put option of the same underlying security. Like a straddle, the options expire at the same time, but unlike a straddle, the options have different strike prices. A strangle can be less expensive than a straddle if the strike prices are out-of-the-money. The owner of a long strangle makes a profit if the underlying price moves far enough away from the current price, either above or below. Thus, an investor may take a long strangle position if he thinks the underlying security is highly volatile, but does not know which direction it is going to move. This position is a limited risk, since the most a purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential

So let’s break down the two contracts:

  • I have a call contract that allows me the ability to call away stock at a price certain regardless of how high the stock actually goes; and
  • I have a put contract that allows me the ability to put the stock to someone at a price certain regardless f how low the stock actually goes.

So, using our example if the stock goes below or above our strike (plus the cost of the trade) we are in profit territory.  If the price of the stock stays in between our markers then the trade will be not be profitable.   So going long (purchasing a strangle contract) means that you don’t necessarily care which direction the stock moves, just that it actually does move.

Going Short on a Strangle Options Contract

Going short on a strangle would be the opposite.  You are taking the position that the stock is going to stay within the set range,

The short strangle, also known as sell strangle, is a neutral strategy in options trading that involve the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date.

In the example above, the contract stays profitable as long as we stay within the two strike prices (35 and 45) plus the premium received from selling the two legs of the trade:

  • Selling the upper call which allows someone to get the stock from me at $45 regardless of how high the stock travels; and
  • Selling the put which allows someone to get me to buy stock from them at $35 regardless of how low the stock has dropped

What’s the Difference Between a Strangle and Straddle?

As soon as I started to research this post I noticed that the strangle and straddle are very similar.  The difference between the two types of options contracts has to do with the relationship between the current stock price and the strike price.

The straddle buy/sells the 2 legs at the same strike price, while the strangle buy/sells the 2 legs at different strike prices.  As such, the long straddle is going to be more expensive, however, more likely to land in the money.  Conversely, the long strangle is going to be less expensive since the legs of the contract are going to be further out of the money (on both ends), however, that means there is a bigger hurdle to get over to profitability.

It is the same idea when comparing the short strangle vs the short straddle.  The short strangle is going to net you less premiums, however, there is a larger margin of error in that the two strike prices are further away from the current price of the stock at the time of sale.

What I dislike/like about the Strangle Options Strategy

Let’s take the easy side of the contract first – I am not sure why a retail investor would sell a short strangle.  The risk seems absolutely ludicrous.  I am sure there is an application for professionals, but the idea of guessing whether a company is going to stay lower than a particular strike price (selling to open a call) seems like a very, very risky proposition.  Then compound it with the “bet” that it’ll stay above a certain price also seems risky, albeit less risky.

Similarly, I do not think I’ll be going long on any strangles anytime soon.  I like the basic neutrality of the strategy, but my price is I am not currently into buying options, as I am currently using options as a way to generate additional investable income.  If you take a volatile stock that you know is going up or down significantly on the next earnings call you better be prepared to pay up because the sellers on the other side are going to be asking top dollar for the premium….so you will need to be ‘right enough’ to cover the premium costs.

Do you have any experience with this strategy?

By | 2017-04-11T00:06:50+00:00 April 11th, 2017|Options|2 Comments

About the Author:

Evan is the owner of My Journey to Millions which was started to track his journey from a broke debt ridden law school graduate to building a positive balance. Need more Evan? Follow him on Twitter, Contact him or get new posts directly to your email

2 Comments

  1. JC April 11, 2017 at 8:43 am - Reply

    Solid write up on the strangle strategy Evan. Although I’m a bit surprised that a short strangle doesn’t sound like something you’d be willing to do. Unless you’re using options solely to exit positions/increase income via covered calls or cash secured puts in order to enter positions, I don’t see why a short strangle is all that different from just selling a call or put. I personally like the short strangle strategy, of course you can’t do it in a IRA account, because you can get your breakevens further out since you’re doubling up on the premium. I’ve also been doing covered strangles in order to generate more option income/premium or reduce my cost basis on positions where I own 100 shares. So far it’s worked out pretty well.

    • Evan April 11, 2017 at 10:06 am - Reply

      JC,

      You make a fantastic point! You are 100% correct, if I am long on a position and I am holding 100 shares of a stock either because I bought them or I have been put/assigned stock already then the short strangle makes perfect sense. I am going to leave the post as it is, but I am holding a few positions where it would make sense.

      My aversion was based on my current distaste for selling uncovered calls.

      Thank you!

Leave A Comment