Option Strangle (Long Strangle) Explained

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Contents

Long Strangle (Buy Strangle) Options Trading Strategy Explained

Published on Thursday, April 19, 2020 | Modified on Wednesday, June 5, 2020

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Long Strangle (Buy Strangle) Options Strategy

Strategy Level Beginners
Instruments Traded Call + Put
Number of Positions 2
Market View Neutral
Risk Profile Limited
Reward Profile Unlimited
Breakeven Point two break-even points

The Long Strangle (or Buy Strangle or Option Strangle) is a neutral strategy wherein Slightly OTM Put Options and Slightly OTM Call are bought simultaneously with same underlying asset and expiry date.

This strategy can be used when the trader expects that the underlying stock will experience significant volatility in the near term.

It is a limited risk and unlimited reward strategy. The maximum loss is the net premium paid while maximum profit is achieved when the underlying moves either significantly upwards or downwards at expiration.

The usual Long Strangle Strategy looks like as below for NIFTY current index value at 10400 (NIFTY Spot Price):

Options Strangle Orders

Orders NIFTY Strike Price
Buy 1 Slightly OTM Put NIFTY18APR10200PE
Buy 1 Slightly OTM Call NIFTY18APR10600CE

Suppose Nifty is currently at 10400 and due to some upcoming events you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty Put at 10200 and buying Nifty Call at 10600. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves.

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When to use Long Strangle (Buy Strangle) strategy?

A Long Strangle is meant for special scenarios where you foresee a lot of volatility in the market due to election results, budget, policy change, annual result announcements etc.

Example

Example 1 – Stock Options:

Let’s take a simple example of a stock trading at в‚№40 (spot price) in June. The option contracts for this stock are available at the premium of:

  • July 35 Put – в‚№1
  • July 45 Call – в‚№1

Lot size: 100 shares in 1 lot

  1. Buy ‘July 35 Put’: 100*1 = 100
  2. Buy ‘July 45 Call’: 100*1 = 100

Net Debit: в‚№100 + в‚№100 = в‚№200

Now let’s discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at в‚№40

In this situation,

  • July 35 Put – Expires worthless
  • July 45 Call – Expires worthless
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Loss = в‚№200

The total loss of в‚№200 is also the maximum loss in this strategy.

Scenario 2: Stock price goes above в‚№50

In this situation,

  • July 35 Put – Expires worthless
  • July 45 Call Expires in-the-money with an intrinsic value of (50-45)*100 = в‚№500
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Profit = в‚№500 – в‚№200 = в‚№300

Scenario 3: Stock price goes down to в‚№30

In this situation,

  • July 35 Put Expires in-the-money with an intrinsic value of (35-30)*100 = в‚№500
  • July 45 Call – Expires worthless
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Profit = в‚№500 – в‚№200 = в‚№300

Example 2 – Bank Nifty

Long Strangle Example Bank Nifty
Bank Nifty Spot Price 8900
Bank Nifty Lot Size 25
Long Strangle Options Strategy
Strike Price(в‚№) Premium(в‚№) Total Premium Paid(в‚№)
(Premium * lot size 25)
Buy 1 OTM Call 9000 200 5000
Buy 1 OTM Put 8800 100 2500
Net Premium (200+100) 300 7500
Upper Breakeven(в‚№) Strike price of Call + Net Premium
(9000 + 300)
9300
Lower Breakeven(в‚№) Strike price of put – Net Premium
(8800 – 300)
8500
Maximum Possible Loss (в‚№) Net Premium Paid 7500
Maximum Possible Profit (в‚№) Unlimited
On Expiry Bank NIFTY closes at Net Payoff from 1 OTM Call bought (в‚№) @9000 Net Payoff from 1 OTM Put Bought (в‚№) @8800 Net Payoff (в‚№)
8000 -5000 17500 12500
8300 -5000 10000 5000
8500 -5000 5000 0
9000 -5000 -2500 -7500
9300 2500 -2500 0
9500 7500 -2500 5000
9800 15000 -2500 12500

Market View – Neutral

When you are unsure of the direction of the underlying but expecting high volatility in it.

Actions

  • Buy OTM Call Option
  • Buy OTM Put Option

Suppose Nifty is currently at 10400 and you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty at 10600 and at 10800. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves.

Breakeven Point

two break-even points

A Options Strangle strategy has two break-even points.

Lower Breakeven Point = Strike Price of Put – Net Premium

Upper Breakeven Point = Strike Price of Call + Net Premium

Risk Profile of Long Strangle (Buy Strangle)

Limited

Max Loss = Net Premium Paid

The maximum loss is limited to the net premium paid in the long strangle strategy. It occurs when the price of the underlying is trading between the strike price of Options.

Reward Profile of Long Strangle (Buy Strangle)

Unlimited

Maximum profit is achieved when the underlying moves significantly up and down at expiration.

Profit = Price of Underlying – Strike Price of Long Call – Net Premium Paid

Profit = Strike Price of Long Put – Price of Underlying – Net Premium Paid

Strangle Option and Straddle Option – A Simple Investment Strategy

Retired from investment banking and teaching, Philip has written several books on investing. Currently working on novel Rape of the Aegean.

What is a Long Strangle?

Buying a long strangle in effect means that the investor is buying a call option (a call gives the buyer the right but not the obligation to buy the underlying asset on a prearranged date in the future) and a put option (a put gives the buyer the right but not the obligation to sell the underlying asset on a future agreed date) on the same currency or stock in the hope that the market moves sharply in either direction to at least break even on the premium paid for engaging in the strategy. (See below link to currency options trading-pay-off diagrams explained) A long strangle will only lose the investor money if the market does not move significantly in one direction or another and fails to cover the premiums which are the investors initial cost.

Investors who engage in strangle strategies are using this strategy to take advantage of the volatility of a currency or a stock price.

  • Currency Options Trading – Pay Off Diagrams Explained
    A currency option pay off diagram visually shows the potential profit and loss and the break even points of an options contract.

Example of a Long Strangle Option

EUR/USD is trading today at 1.4210 so the investor buys two lots of June long calls at a strike price of 1.4200 (out of the money) and pays a premium of 50 pips representing a cost of $100,000x2x0.0050 = $1000 and at the same time buys 2 lots of June long puts at a strike price of 1.4225 (out of the money) and pays a premium of 25 pips representing a cost of 100,000x2x0.0025=$500, so the total cost for the Long strangle strategy is $1,500. This represents the total loss that the investor will incur if the options expire worthless.

The strategy for the investor here is that the options investor expects the EUR/USD to be either bullish or bearish. The investor doesn’t care and will be happy whichever way the currency moves.

A gain however can be made in either direction. If the EUR/USD rises above 1.4275 (strike price plus the combined premiums paid) the investor will allow the put to expire worthless and then the profit from the call is unlimited. However, if the EUR/USD falls below 1.4150 (the put strike price plus the combined premiums paid) the investor will allow the call option to expire and here again the profit potential is unlimited.

If the EUR/USD is at the 1.4200 strike price on expiry the investor will allow the call option to expire and exercise the put option thereby reducing the amount of loss by $500 due to the profit made on the put option. The chart below shows at what price points the investor would exercise the options or let them expire.

Long strangle options are attractive to investors who are anticipating an instability in the market or on their currency. Times of uncertainty and unexpected news can be a good time to take on a long strangle option strategy.

Straddle Strategy

The option straddle strategy is similar to a Strangle strategy except that the long call and long put are, unlike the Strangle, at exactly the same strike price and as with the Strangle, the same expiry date. Straddles are a good strategy to pursue if an investor believes that currency prices will move considerably but is unsure as to which direction. The currency price must move appreciably if the investor is to make a profit. A small price movement in either direction will cause the investor to take a loss. Consequently, a straddle is an extremely risky strategy to perform.

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

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Comments

Philip Cooper

8 years ago from Olney

Thanks for dropping by.

wlionpage

8 years ago from Ahmedabad, Gujarat, India

I really appreciate your efforts, Thanks I am on Amplify:- http://dishapatel.amplify.com/

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Long Strangle Option Strategy In Python

Introduction

Today, we are going to talk about the Long Strangle trading strategy.

What is ‘Long Strangle’ in Options trading?

Strategy highlights

Maximum Loss: Call Premium + Put Premium

Breakeven: Breakeven on the Upside = Strike Price + Call Premium + Put Premium

Breakeven on the Downside = Strike Price – Call Premium – Put Premium

How to implement this strategy?

Last 1-month stock price movement (source – Google Finance)

There has been a lot of movement in the stock price of Fortis, the highest being INR 157.30 and lowest being 114.20 in last 1 month. The current value being INR 138.90 as per Google Finance and an IV of 83.35%

For the purposes of this example; I will buy 1 out-of-the-money put and 1 out-of-the-money call Options.

Here is the option chain of Fortis for the expiry date of 22 nd February 2020.

I will pay INR 4 for the put with a strike price of INR 135 and INR 3.50 for the call with a strike price of INR 145. The options will expire on 22 nd February 2020 and in order for me to make a profit out of it, there should be a substantial movement in the Fortis stock before the expiry.

The net premium paid to initiate this trade will be INR 7.50 hence the stock needs to move down to INR 127.5 on the downside or INR 152.50 on the upside before this strategy will break even. Considering the massive amount of volatility in the market due to various factors and taking into account the market recovery process from the recent downfall we can assume that there can be an opportunity to book a profit here.

How to calculate the strategy payoff in Python?

Importing libraries

Defining parameters

Call payoff

Put payoff

Strangle payoff

As you can see in the above Payoff plot the maximum anyone can lose is the total premium paid for holding both call and put positions i.e. INR 7.50 in my case. This is when the strike price falls between the two options that we have purchased at the time of its expiry.

On the other hand, there is no limit for the profit that you can gain once the stock price moves significantly in any direction.

In my next post, I will be talking about the ‘Bull Call Spread Strategy’

Next Step

Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.

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