Straddle and strangle Strategies in England are generally thought to be contrarian investment strategies that provide adequate investment returns. They are premised on the idea of buying both a put option/straddle, which confers the right but not obligation to sell an underlying security at a predetermined price on or before a preset date, as well as a call option/strangle, which confers the right but not obligation to buy an underlying security at a predetermined price on or before a preset date.
The straddle and strangle strategies are common strategies to use when trading options. Although these strategies produce immediate income, they should be handled with care due to the risk attached.
If a trader believes that the price of a stock will move sharply in either direction, he can enter into a long straddle or a short strangle strategy. The basic premise of the straddle and the strangle is simple: you buy an equal number of calls and puts at-the-money with strike prices close to one another for stocks you think have potential for significant movement in either direction.
The Long Straddle
The long straddle is used when you think that the price of a stock will make a substantial move after important news has been released. When you buy both an at-the-money call option and an at-the-money put option, you are essentially covered for either direction of movement. Whether the underlying asset’s price goes up or down, one can still hope to profit given an equal magnitude of movement in either direction.
Your potential losses are limited just as much as your potential gains. With this said, shareholders could face large losses if there is no significant movement in the market following the news release.
Option premium for purchasing straddles is usually very high as the potential for a significant move is high. The problem with this strategy is that it can be challenging to predict just how much the market will move, and as such if you buy the straddle wrong, you could leave yourself seriously out of pocket. A long straddle should not be used without an opinion on anticipated movement or unless news has been released and there is no clear trend between scenarios.
The Short Strangle
Just like the long straddle, the short strangle involves buying both a call and put option where the strike prices (for each) are different but closer to one another than if they were at-the-money options. With this strategy, your prediction for movement is the same as with the long straddle, and you just have a different opinion on how big that movement will be. If you place a short strangle incorrectly, it may result in a substantial loss if there is a significant enough move against your position.
Option premium for selling a strangle is usually low compared to buying at-the-money options as the potential for making a significant profit from movement is less likely. The problem with this strategy is that it can be challenging to predict just how much the market will move, and as such if you sell the strangle wrong, you could end up leaving yourself seriously out of pocket. A short strangle should not be used without an opinion on anticipated movement or unless news has been released and there is no clear trend between scenarios.
When should you use these strategies?
Some market participants have found that straddle/strangle strategies are popular at certain times of the year, notably January and December for put options, May through June for call options, September through November for put options, October for call options.
Bottom Line
Many factors affect whether an investor should use straddles/strangles or not – the most important being the cost of implementing them! Many brokerage platforms now allow you to trade these strategies virtually free of cost. It is always worth checking with a reputable online broker like Saxo Bank before attempting options trading and implementing these strategies.
