Strangle Options Strategy: Understanding How It Works With an Example

What is the Strangle Options Strategy?

The Strangle Options Strategy is a popular trading strategy used in the world of options and derivatives. It is designed to take advantage of market volatility and can be used by both experienced traders and beginners.

This strategy involves buying both a call option and a put option with the same expiration date, but with different strike prices. The call option is purchased with a strike price above the current market price, while the put option is purchased with a strike price below the current market price.

The idea behind the Strangle Options Strategy is to profit from significant price movements in either direction. If the market price moves significantly higher, the call option will increase in value, while the put option will expire worthless. On the other hand, if the market price moves significantly lower, the put option will increase in value, while the call option will expire worthless.

The strangle options strategy is a type of neutral strategy that involves buying both a call option and a put option with the same expiration date but different strike prices. This strategy is typically used when the trader expects a significant price movement in the underlying asset, but is unsure of the direction of the movement.

Components of a Strangle Options Strategy

A strangle options strategy consists of the following components:

  1. Call Option: A call option gives the buyer the right to buy the underlying asset at the strike price before the expiration date.
  2. Put Option: A put option gives the buyer the right to sell the underlying asset at the strike price before the expiration date.
  3. Expiration Date: The expiration date is the date at which the options contract expires and becomes invalid.
  4. Strike Prices: The strike prices are the predetermined prices at which the buyer can exercise the options.

How the Strangle Options Strategy Works

The strangle options strategy works by taking advantage of a significant price movement in the underlying asset. If the price of the asset moves significantly in either direction, the trader can profit from the strategy.

When implementing a strangle options strategy, the trader buys both a call option and a put option. The call option is typically purchased with a higher strike price, while the put option is purchased with a lower strike price. This allows the trader to profit from a price movement in either direction.

If the price of the underlying asset increases significantly, the call option will be profitable, while the put option will expire worthless. On the other hand, if the price of the underlying asset decreases significantly, the put option will be profitable, while the call option will expire worthless.

Example of a Strangle Options Strategy

Let’s consider an example to better understand how a strangle options strategy works:

Component Details
Call Option Strike Price: $50
Expiration Date: 30 days
Put Option Strike Price: $40
Expiration Date: 30 days

If the price of the underlying asset increases to $60, the call option will be profitable, while the put option will expire worthless. On the other hand, if the price of the underlying asset decreases to $30, the put option will be profitable, while the call option will expire worthless.

The strangle options strategy allows traders to take advantage of significant price movements in the underlying asset, regardless of the direction of the movement.

Example of a Strangle Options Strategy

Let’s take a look at an example to better understand how the strangle options strategy works. Suppose you are a trader and you believe that a particular stock, let’s say XYZ, is going to experience a significant price movement in the near future, but you are unsure about the direction of the movement.

You decide to implement a strangle options strategy to take advantage of this uncertainty. Here’s what you do:

Step 1: Identify the Strike Prices

You start by identifying the strike prices for your strangle options strategy. The strike price for the call option should be higher than the current market price of XYZ, while the strike price for the put option should be lower than the current market price.

For example, let’s say the current market price of XYZ is $100. You choose a call option with a strike price of $110 and a put option with a strike price of $90.

Step 2: Buy the Options

Buying the call option gives you the right to buy XYZ at the strike price of $110, while buying the put option gives you the right to sell XYZ at the strike price of $90.

Step 3: Wait for the Price Movement

Now, you wait for the price movement of XYZ. If the price of XYZ increases significantly, let’s say to $130, the call option will be in the money, and you can exercise your right to buy XYZ at $110 and then sell it at the higher market price of $130, making a profit.

On the other hand, if the price of XYZ decreases significantly, let’s say to $70, the put option will be in the money, and you can exercise your right to sell XYZ at $90 and then buy it at the lower market price of $70, again making a profit.

Step 4: Calculate the Profit or Loss

To calculate your profit or loss, you need to consider the premiums you paid for the call and put options. If the price movement is not significant enough, both options may expire out of the money, resulting in a loss.

Overall, the strangle options strategy allows you to take advantage of volatility and uncertainty in the market, providing you with the potential for profit in both bullish and bearish scenarios.