Strangle is an options trading strategy that involves purchasing both a call and put with the same strike price. This strategy will provide limited profits but unlimited losses. The main idea behind strangle is that significant moves are nearly always preceded by many smaller price movements.
Strangles are also a neutral trading strategy ideally suited to range-bound markets as they benefit from either side of the trade moving strongly in opposite directions.
A Bull Strangle
A bull strangle is often used when investors expect moderate upside volatility but want to ensure that they participate in the significant movement. It can be seen as using both bullish spread and bearish spread strategies simultaneously.
A Bear Strangle
On the other hand, a bear strangle benefits from limited downside movement or implied volatility contraction while capturing some upside potential. The best results for this approach will come when underlying security changes direction by more than anticipated in the premium paid for both buys.
A significant move in either direction within a short period will be unprofitable in many cases, even if it is as anticipated.
Using Calls and Puts
If investors expect the market to rise or fall strongly before expiration, they can profit from a bull strangle using calls and puts with strike prices nearest the current market price. The resulting position is profitable if there is significant movement in either direction.
However, this strategy will lose money as time passes, and extrinsic value decays on both options without such strong directional moves. This approach appeals to traders who want to take advantage of volatility contraction during periods of low movement and those anticipating strong movement but unable to predict its particular direction.
The best results for this approach will come when underlying security changes direction by more than anticipated in the premium paid for both buys. A significant move in either direction within a short period will be unprofitable in many cases, even if it is as anticipated.
Risks of Using Strangle and Straddle Strategies
Options traders often find that strangles are ill-suited to highly volatile markets with persistent up- or downtrends. In such circumstances, straddles and strangles produce undesirable risk/reward ratios. Their profit potential is limited to extrinsic value decay over time while still subject to directional losses from long calls and puts. This makes them unattractive alternatives compared to dynamic strategies, which can profit from increased implied volatility.
Once the stock makes its first big move, it will either rise/fall or settle at another point. Either way, if these options are held until expiration, there won’t be much profit gained. However, it should be noted that this whole time there would have been no stop-losses as there was never any momentum for the prices to drop past your break-even points.
Due to this lack of momentum, strangles can take a long time to play out, unlike other straddle or strangle strategies that deal with higher volatility. For this reason, most traders will cut their losses and sell when the stock reaches a predetermined price to avoid having their options expire worthless.
For example, if an investor had sold call/puts on APPLE just before they announced earnings (which is very often), then investors would have been able to lock in approximately $4 of the $5 move on that day alone.
On top of that, since Apple has such a large market cap and so many shares traded daily, it will not take much movement before your option prices increase significantly. Therefore by selling strangles around significant news announcements, it is possible to earn a good amount of money.
New traders interested in forex trading are advised to contact a reputable online broker from Saxo Bank to help them get started on their investment journey.