Option Strangle (Long Strangle)
The long strangle, also known as
buy strangle or simply "strangle", is a neutral strategy in options
trading that involve the simultaneous buying of a
slightly out-of-the-money put and a slightly out-of-the-money
call of the same underlying stock and expiration date.
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The long options strangle is
an unlimited profit, limited risk strategy that is taken when the options
trader thinks that the underlying stock will experience significant volatility
in the near term. Long strangles are debit spreads as a net debit is
taken to enter the trade.
Unlimited Profit Potential
Large gains for the long
strangle option strategy is attainable when the underlying stock price makes a
very strong move either upwards or downwards at expiration.
The formula for calculating
profit is given below:
- Maximum
Profit = Unlimited
- Profit
Achieved When Price of Underlying > Strike Price of Long Call + Net
Premium Paid OR Price of Underlying < Strike Price of Long Put - Net
Premium Paid
- Profit =
Price of Underlying - Strike Price of Long Call - Net Premium Paid OR
Strike Price of Long Put - Price of Underlying - Net Premium Paid
Limited Risk
Maximum loss for the long
strangle options strategy is hit when the underlying stock price on expiration
date is trading between the strike prices of the options bought. At this price,
both options expire worthless and the options trader loses the entire initial
debit taken to enter the trade.
The formula for calculating
maximum loss is given below:
- Max Loss =
Net Premium Paid + Commissions Paid
- Max Loss
Occurs When Price of Underlying is in between Strike Price of Long Call
and Strike Price of Long Put
Breakeven Point(s)
There are 2 break-even points
for the long strangle position. The breakeven points can be calculated using
the following formulae.
- Upper
Breakeven Point = Strike Price of Long Call + Net Premium Paid
- Lower
Breakeven Point = Strike Price of Long Put - Net Premium Paid
Example
Suppose XYZ stock is trading
at $40 in June. An options trader executes a long strangle by buying a JUL 35
put for $100 and a JUL 45 call for $100. The net debit taken to enter the trade
is $200, which is also his maximum possible loss.
If XYZ stock rallies and is
trading at $50 on expiration in July, the JUL 35 put will expire worthless but
the JUL 45 call expires in the money and has an intrinsic value of $500.
Subtracting the initial debit of $200, the options trader's profit comes to
$300.
On expiration in July, if XYZ
stock is still trading at $40, both the JUL 35 put and the JUL 45 call expire
worthless and the options trader suffers a maximum loss which is equal to the
initial debit of $200 taken to enter the trade.
Note: While we have covered
the use of this strategy with reference to stock options, the long strangle is
equally applicable using ETF options, index options as well
as options on futures.