Strangle Option Strategy: Is It Right For You?

• Strangle options involve buying (long strangle) or selling (short strangle) both a call and a put option on the same underlying asset with different strike prices and the same expiration date.
• Long strangles profit from significant price movements in either direction, while short strangles profit from limited price movement (range bound).
• Benefits include profiting from volatility (long strangle) or collecting premium (short strangle).
• Risks include premium costs, time decay (long strangle), margin requirements (short strangle), and unexpected volatility changes.

To get an edge over other traders, a seasoned investor needs to be aware of multiple trading strategies. Keeping such strategies in your arsenal can provide you with the tools to succeed at trading.One of the most popular trading strategies in the world of investing is the strangle option strategy. In this blog, we will delve into strangle strategy meaning in stock market .

Let’s cover some basic terms before delving into the strangle option trading strategy.

• Call Option: A call option gives the contract holder the right, but not an obligation to buy an asset at a specified time and a specified price. These are usually bought by traders when they are bullish on a stock.
• Put Option : A put option is the opposite of a call option. It gives the option holder the right, but not the obligation to sell a stock at an agreed upon time and price. This contract is usually bought by traders when they are bearish on a stock.
• Strike Price: It is the price at which an option holder can buy or sell a stock.
• Premium: Premium is what a trader pays to the seller for providing options in online trading.
• In-The-Money option (ITM): When the price of the underlying stock is higher compared to the strike price, it's said to be ITM.
• Out-of-the-money option (OTM): OTM happens when the strike price of an option happens to be more than that of the underlying asset.
• At-the-money option (ATM): In this option, the underlying asset's price is exactly equal to the strike price of the contract in this case.

The strangle option strategy consists of a trader buying both put and call options. The underlying asset for both option contracts remain the same. However, the strike price for both these options is different.Thus, what the strangle option trading strategy really aims to do is profit from big market moves, regardless of the direction of the underlying price change.The strangle strategy in options works on the basic principle that there is no directional bet taken by the trader on the market. The trader has simply put themselves in a position to benefit from greater volatility. This can result in substantial gains if the underlying moves sharply in price to either side.There are two main variations of this strategy: the long strangle and the short strangle.

There are two main variations of this strangle option trading strategy, the long strangle and the short strangle.

Long Strangle Option Strategy

A long strangle involves buying both an OTM call option and an OTM put option. This strategy is typically employed when a trader anticipates a significant move in the underlying asset's price but is unsure of the direction. Example of a long strangle option strategy using a company called XYZ: Let's say XYZ is currently trading at 18,000 points. A trader implements a long strangle by:

• Buying a XYZ 18,500 Call option (OTM) for ₹50
• Buying a XYZ17,500 Put option (OTM) for ₹45

The total cost (premium paid) for this position is ₹95 per lot (₹50 + ₹45).
Potential outcomes:

• If XYZ rises above 18,595 (upper breakeven point), the strategy becomes profitable.
• If XYZ falls below 17,405 (lower breakeven point), the strategy becomes profitable.
• Maximum loss is limited to the premium paid (₹95 per lot) if XYZ remains between 17,500 and 18,500 at expiration.

Short Strangle Option Strategy

On the other hand, a short strangle sells both an out-of-the-money call and an out-of-the-money put option. In this case, the trader expects the underlying instrument to stay range bound. Example of a short strangle option strategy: Using the same XYZ level of 18,000 points, a trader implements a short strangle by:

• Selling a XYZ 18,500 Call option (OTM) for ₹50
• Selling a XYZ17,500 Put option (OTM) for ₹45

The total premium received for this position is ₹95 per lot (₹50 + ₹45).
Potential outcomes:

• Maximum profit is limited to the premium received (₹95 per lot) if XYZ remains between 17,500 and 18,500 at expiration.
• The strategy becomes unprofitable if XYZ moves above 18,595 or below 17,405 (breakeven points).
• Potential losses are theoretically unlimited if XYZ makes a significant move in either direction.

Risks and Considerations of Strangle Option Strategy

Despite the numerous benefits of using the strangle strategy in options trading, there are some risks associated using the strangle stock option strategy.

• Premium costs : This can get pricey, especially in high-volatility environments, with the cost of both options in a long strangle.
• Time decay : Long strangles suffer from time decay, while short strangles benefit.
• Margin requirements: The reason most short strangles are highly margined is that potential losses, theoretically, may be unlimited.
• Volatility changes: A decrease in implied volatility hurts the long strangle strategies but benefits the short strangles.

Also Read: Best Option Trading Strategies You Should Know

You can improve your options trading strategies when you understand the mechanics, benefits, and risks of executing strangle strategy in options using both long and short strangles. Of course, as in all successful options trading, detailed research, careful practice, and astute risk management remain critical considerations.