Both option strategies straddle and strangle allow investors to earn profit in volatile market conditions. You can take advantage of this increasing volatility. Some scenarios arise, when you are expecting a big move in a specific stock, but are not aware of the direction. Fortunately, you can profit from these moves. It does not matter if they are up or down. Long strangle or straddle option fit this condition.
Both strategies comprise of purchasing equal amount of call and put of same asset with the same expiration date. However, the difference lies in their strike price.
- Strangle has 2 different strike prices
- Straddle has 1 common strike price
Both strategies are expensive options but the maximum risk limit is fixed (means you know it). The biggest risks for these strategies are drops in IV (implied volatility) and time decay.
You need to buy ATM call and same ATM put. The concept is that if the underlying asset price increases or decreases significantly selling the CALL or PUT at new value for more cost than its purchase value, you profit.
Strangle too takes the similar approach, but makes use of OTM call and put. It is a low-cost trade that will need a huge move to earn profits.
How straddle and strangle work?
Both trading options straddles and strangles can be profitable, if the movement of underlying asset is up or down, significantly. You are actually paying two premiums and buying the value as well as time of both sides.
Therefore there needs to be extensive movement to create huge profits. Strangle or straddle traders must remember not to hold their positions, when expiration gets close because time decay is more in those moments. When implied volatility (IV) is low, it is best to purchase options.
This strategy goes wrong, when stock price will not move sufficiently to balance time decay or fall in IV. Debit paid is the maximum risk. If IV drops, then the position can lose its value, even if underlying asset moves. Therefore, it is advised to apply straddle & strangles, after the announcements of earning news or other events. Even if stock moves, after news is released, the drop in IV can offset the profits to be gained from changes in underlying asset.
When to use straddle & strangle?
To gain profits Forex traders need to find a currency pair with strong resistance above and below. There needs to be sufficient room for the value to adjust normal daily changes.
Short strangle having strike prices beyond support & resistance level can be lucrative. Alternatively, if price reaches a point of break out then long straddle or strangle is suitable. If triangle displays that the breakout is likely on one side, then adjust strike prices accordingly.
Strangles is a low premium strategy when compared to straddles. However, the possibility of losing your entire premium is high. In case your prediction of low volatility is right and you purchased a straddle, then you gain profits. However, if the stock makes extreme move, then strangle option will generate high payouts. Your decision will rely on your conviction, expectations, and risk tolerance.
Both trade option strategies straddles & strangles can take advantage of a supposed mispricing, where trader predicts that premium or implied volatility does not signify the movement of underlying asset. The trader cannot provide a strong directional judgment. Straddles & strangles are tempting but needs definite consideration of short straddle & strangle risks.