Long and short strangles differ in
their response to market movements. They are however both neutral strategies.
The long strangle achieves maximum profit when the market moves in either
direction; it does not matter whether the move is $10 up or $10 down the
movement will have the same impact on profit. The short strangle relies on the
market moving sideways to achieve maximum profits, therefore is also a neutral
strategy.
Long strangles
can be compared to long straddles, in the way in which they rely on market
movements in either direction for profit. Strangles are less risky due to being
initiated with less expensive near the money options rather than at the money
options.
Example:
If we imagine a stock trading at $65 per share. We would buy one 60 Put at $2.25
and one 70 Call at $2.50. The Strangle would have a cost of $475 ((2.25 + 2.50)
x 100), this also being the total amount we could lose. If the stock was
anywhere between $60 and $70 we would incur the maximum loss. Our upside
breakeven is $74.75 ($70 + $4.75) and our downside breakeven is $55.25 ($60 –
$4.75). Anywhere outside these breakeven points the position will begin to show
a profit.
Using ShareCharts
Option Strategies for The Strangle the entire transaction can be seen clearly.
Go to Derivatives < Option Strategies and select The Strangle from the
‘Strategy’ Drop Down Box. Enter in all relevant parameters and click
‘Update’ to view the chart.
The Long Straddle can also be formed using in the money options, using the same example as above.
Example:
With the stock price at $65 per share we would buy the 60 Call at $7 and buy the
70 Put at $6.75. The total cost of this strategy is $1375, with the stock
between $60 and $70 the strategy will be worth $10, due to the intrinsic vale
still left in the options, thus the most we stand to lose is $375 ($13.75 -
$10).
This
makes the maximum loss for in the money options less than that for the near the
money options, 3.75 as opposed to 4.75, even though the initial outlay is much
higher. The $10 value comes from the maximum loss point of $65 where the Put and
the Call both have a premium value of $5 each.
Using ShareCharts
Option Strategies for The Strangle the entire transaction can be seen clearly.
Go to Derivatives < Option Strategies and select The Strangle from the
‘Strategy’ Drop Down Box. Enter in all relevant parameters and click
‘Update’ to view the chart.
ShareChart only
covers long straggles.
The
short strangle is much like the short straddle in that they both profit in
sideways markets and have unlimited loss potential on either side. The Strangle
actually got its name in 1978 when some IBM option traders holding this position
lost everything due to some large and unpredicted price movements.
Example:
Take a stock trading at $65 we would sell the 60 Put for $2.25 and sell the 70
Call for $2.50. Making the total cost $475. This would also be our total profit.
If the stock stays between $60 and $70 we will keep this premium as profit. With
the upside breakeven being $74.75 (70 + 4.75) and the downside breakeven being
55.25 (60 – 4.75) anywhere outside these points the position will begin to
show a loss.
The short strangle can also be
created using in the money options, and this particular kind of strangle is also
referred to as the ‘guts’. Using the same example as above,
Example:
With the stock price at $65, we would sell the 60 Call at $7 and sell the 70 Put
at $6.75. The total cost of this strategy is $1375. With the stock between $60
and $70 the strategy will be worth $10, due to the intrinsic vale still left in
the options, thus the most we stand to lose is $375 ($13.75 - $10).
While
the profit is less from the short strangle at 3.75 as opposed to 4.75 in the
long strangle, the short strangle would earn more interest income as they would
have collected $1375 instead of $475 from the long strangle.
This
makes the maximum loss for in the money options less than that for the near the
money options, 3.75 as opposed to 4.75. The $10 value comes from the maximum
loss point of $65 where the Put and the Call both have a premium value of $5
each.