Straddle and Strangle Strategies to Deal in the Options
Straddle and strangle are the strategies for the trader of the options. These strategies help investors manage risk to some extent and generate profit by entering the options contract. In both of the strategies, the investors enter in the call and put options. However, there is a difference in the strike prices between strategies while entering into the contract.
It is important to note that not all the straddle and strangle strategies end up in the profits as there can be losses if there is no significant fluctuation in the price of the underlying assets. Let’s discuss in detail that how these strategies are implemented and the difference between them.
Straddles and how traders make a profit with it
The straddle is the trading strategy in options where both call and put options are purchased for the underlying asset with the same strike price and the exact date of expiry.
The most significant advantage of this strategy is that there is profit on both sides of the movement’s underlying security price. It does not matter if the price of the underlying asset increases or decreases. It just has to cross the breakeven boundaries to make a profit for the trader.
Example of the straddle strategy
Suppose the call option of the underlying security is trading at USD 5 per option. The put option is trading at USD 3 with the same strike price of USD 80, the exact date of expiration, and the same underlying asset. So, if the investor decides to implement a straddle strategy and enters a contract for the hundred call options and hundred put options. The premium on entering this strategy will be USD 800 (500+300).
In the future, If the price of the underlying asset goes up and it exceeds the total premium paid by the investor, they will be in the profit as a call option can be exercised that generates the gain. Similarly, if the underlying security price goes down, the investor can sell the underlying security at the pre-agreed price by exercising the put option.
However, it is essential to note that there is a set-off of the premium as the worth of the underlying security either increases or decreases. In the given situation, the investor makes a profit if the price of the underlying security moves by USD 8 per option in either direction as its boundary of the break-even.
To further understand the concept, suppose the trading price of the underlying security moves to USD 100. The put option expires without any benefit, and the call option adds value by 2,000 (20*100). After deduction of the premium, the trader is left with a profit of USD 1,200 (2,000-800).
Strangles options strategy
Strangles strategy of the options is similar to the straddle strategy. However, there is a difference in the strike prices of call and put options while the expiration date and the underlying assets remain the same for both.
It is important to note that the profit with the strangle strategy can only be made when underlying assets swing sharply in the price same as the straddle. Since strike price is not the same in this case. So, more profit is made when there is a more significant difference in the strike price and the underlying security price.
Example of the strangle options strategy.
Consider the share of the XYZ Company is currently trading at the USD 50 per share. The investor enters the strangle strategy with a call option of USD 52 as strike price and premium USD 3. It means the total cost of the call options for 100 shares is USD 300 (100*3).
Similarly, the put options premium is USD 2.85, with a strike price of USD 48. So, the premium to be paid on the put option amounts to USD 285 (2.85*100), and the total premium on call and put options will be USD 585 (300+285).
It’s important to note that strike prices are different for both the call and put options. On the contrary, the strike price was the same for both call and put options in the straddle strategy.
Now, suppose the share price of the XYZ Company remains between USD 48 and USD 52. In that case, it’s not a profitable situation for the investor as if they exercise its right in this range of the price. There will be no profit in the transaction as it will be set off against premiums paid on both calls and put options.
However, suppose there is some more volatility in the price range and the price of the underlying asset fall to USD 38. In that case, the put option adds value for the investor amounting to 10 (48-38) per option, and the premium paid for the call option amounting to USD 300 is a loss.
In this situation, the put option has added a value of USD 1,000 (10*100) against a premium of USD 285. The premium paid for the call option amounting to 300 expires without adding any value. So, the total profit on this straddle is USD 415 (1,000-285-300). Although there was some loss on the call option still there is profit for the investor due to the put option.
Now, consider the share price of the XYZ company moves to USD 60. In this situation, the put option is straight loss, and the value-added by the call option amounts to USD 8 (60-52) per option and 800 for 100 options. However, we need to deduct the total premium and are left with a profit of USD 215 (800-300-285).
In both of the strategies, the investor has obtained the profit. However, the only situation required is significant fluctuation in the underlying asset price that must exceed the range of the breakeven boundaries. Further, it’s a matter of the expected situation when to use the straddles and strangle. Both strategies can be profitable if the investor successfully predicts price movement/stock volatility with accuracy.