Strangle (options)

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In finance, a strangle is a trading strategy involving the purchase or sale of two options, allowing the holder to profit based on how much the price of the underlying security moves, with minimal exposure to the direction of price movement. A strangle consists of one call and one put with the same expiry and underlying but different strike prices. Typically the call has a higher strike price than the put. If the put has a higher strike price instead, the position is sometimes called a guts.[1]

If the options are purchased, the position is known as a long strangle, while if the options are sold, it is known as a short strangle. A strangle is similar to a straddle position; the difference is that in a straddle, the two options have the same strike price. Given the same underlying security, strangle positions can be constructed with lower cost and lower probability of profit than straddles.

Strangles can be used with equity options, index options or options on futures.

Long strangle[]

Payoffs of buying a strangle spread.

The long strangle, also known as a bottom vertical combination,[2] involves going long (buying) both a call option and a put option of the same underlying security. Like a straddle, the options expire at the same time, but unlike a straddle, the options have different strike prices. A strangle can be less expensive than a straddle if the strike prices are out-of-the-money. If the strike prices are in-the-money, the spread is called a gut spread. The owner of a long strangle makes a profit if the underlying price moves far enough away from the current price, either above or below. Thus, an investor may take a long strangle position if he thinks the underlying security is highly volatile, but does not know which direction it is going to move. This position is a limited risk, since the most a purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential.[3]

Short strangle[]

payoff of short strangle

The short strangle strategy, also known as a top vertical combination,[2] requires the investor to simultaneously sell both a [call] and a [put] option on the same underlying security. The strike price for the call and put contracts must be, respectively, above and below the current price of the underlying. The assumption of the investor (the person selling the option) is that, for the duration of the contract, the price of the underlying will remain below the call and above the put strike price. If the investor's assumption is correct the party purchasing the option has no advantage in exercising the contracts so they expire worthless. This expiration condition frees the investor from any contractual obligations and the money (the premium) he or she received at the time of the sale becomes profit. Importantly, if the investor's assumptions against volatility are incorrect the strangle strategy leads to modest or unlimited loss.

See also[]

  • Condor (options)
  • Ladder (option combination)

References[]

  1. ^ Natenberg, Sheldon (2015). "Chapter 11". Option volatility and pricing: advanced trading strategies and techniques (Second ed.). New York. ISBN 9780071818780.
  2. ^ a b Hull, John C. (2006). Options, futures, and other derivatives (6th ed.). Upper Saddle River, N.J.: Pearson/Prentice Hall. pp. 234–236. ISBN 0131499084.
  3. ^ Barrie, Scott (2001). The Complete Idiot's Guide to Options and Futures. Alpha Books. pp. 120–121. ISBN 0-02-864138-8.

External links[]

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