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Strangle Option

A strangle is an options strategy that allows investors to benefit if they accurately predict whether the price of a stock will change dramatically or stay inside a narrow price range.

A long strangle allows investors to profit when a stock's price moves dramatically, while a short strangle allows investors to profit when the price stays within a certain band.

Strangle Option Meaning

A strangle is a strategy for profiting on forecasts about whether the price of a stock will fluctuate significantly. Purchasing or selling the call option with the strike price higher than the stock's spot price and the put option with a strike price lower than the current price constitutes a strangle.

How Does Strangle Option Strategy Work?

An investor uses the strangle option technique when he has a stake in both a call and a put option on the very same asset with the very same expiration date. These options, however, have distinct strike prices.

As an investor, this lets you profit from price swings in the underlying asset, regardless of which way they occur. This technique is advantageous if an options investor is confident in the probability of a sharp swing in the price of an asset but not in the direction.

Terminologies associated with the Strangle Strategy

Put Option:

While the call option gives you a choice to buy, the put option gives you the opportunity to sell the stock at the agreed-upon price on the agreed-upon date.

Call Option:

A Call Option is a contract in which you win the right, but not the responsibility, to purchase a specific underlying asset at a price and date agreed upon by the contracting parties.

Spot Price: 

The options contract is linked to the current price of the underlying asset.

Strike Price:

The initial purchase price of the options contract or a predetermined price.

In-the-money-option:

When the price of the asset gets higher than the strike price.

Premium:

It is the fee you pay to the seller of an option to participate in online trading.

Out-of-the-Money-Option:

It is when the price of the asset is less than the strike price.

At-the-Money-Option:

It is when the price of the underlying asset is the same as the strike price of the contract.

Types of Strangles

Short strangles and lengthy strangles are the two forms of strangles.

 

Long Strangle

Short Strangle

 Meaning 

A long strangle allows investors to profit from a substantial gain or drop in the price of a stock without having to predict the direction of the change.


Using this method, investors purchase call options with strike prices higher than the market price and put options with strike values lower than the market price. The investor would lose the money they spent on the options if the share price remains between the two strike prices. They could exercise the option to buy shares below market value if the stock price climbs above the call price. They can acquire shares at market price and exercise the put to sell them for a gain if the price falls below the strike price of the put option.

When the price of the stock does not change considerably, short strangles allow investors to benefit. Short-strangle investors sell call options with strike prices higher than the current share price and put options with strike prices lower than the current share price.


The investor makes money if the stock price stays between the strike values of the options. The investor may lose money if it increases or falls outside that range. When the distinction between the two strike prices is lower, profits are usually bigger.

Example

Long Strangle Option Example:-


When Mr A buys a call with a strike of 55 and a put with a strike of 45 and sets up a long strangle on stock XYZ, which is now trading at 50. If the price rises, you will make the following profit:


(100x[market value–55]) – (call price+put price)


If the price falls - his profit will be:


(100x[45–market value]) – (call price+put price)


If the price stays between 45 and 55, Mr A will lose the money you invested in the options.

Strangle Option Strategy Example:-


Mr. A would sell a call at 55 and a put at 45 to set up a short strangle on XYZ. He would keep the premium you received from selling the options if the price stays in that range. If the price drops below 45, you will lose the following:


(call price+put price) - (100x[45–market value])


If the price exceeds 55, he will lose:


(call price + put price) – (100x[market value–55])

Benefits of Using the Strangle Option

  • The higher the profit from executing the call or put option, the greater the increase or drop in the stock price. Furthermore, because the stock price has no upper limit, the possible return from the call option has no upper limit as well.
  • Sell your options again. One exit strategy is to resell your options if you grow less confident that the stock price will change enough before the options expire or just wish to lock in winnings. This can help you realize profits before the options expire or reduce losses if the options have already lost value but aren't yet worthless.
  • Losses are restricted to the amount you paid for the options. Using a strangle, the possible loss is restricted to the value of the options you paid. As a result, the strangle provides a somewhat uncommon mix of infinite gain and limited risk.

Strangle Option - FAQs

Q1. What is the selling strangle option?

A strangle strategy is an options strategy in which you buy (sell) an out-of-the-money call and put in the same underlying and expiration.

Q2. What is the formula for short strangle?

Put strike price minus the premium received or call strike price plus premium received. A short strangle two breakeven points, depending on which way the stock moves. If the stock starts to increase, the call strike price plus the premium received is the upper breakeven point.

Q3. What are the risks of Strangle Option?

Only lucrative after a significant change in the strike price of the underlying asset. As out-of-the-money options are employed, it carries a higher risk than other techniques. Time decay has a negative impact on profitability.

Q4. What is the meaning of spot price?

It is the current price of the underlying asset.

Q5. When is a strangle useful?

They are useful when the investor thinks that it is likely the stock would move one way or the other and wants to be protected if it is this case.

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