The long strangle strategy in option helps traders to take advantage of the volatility in the market. The long strangle in option chain has limited risk and unlimited profit.
Long strangle is an options trading strategy which involves buying an out of money call option and an out of money put option in same underlying assets and options expiration date. It is similar to a long straddle but only the difference is call option and put option are at different strike prices in a long strangle. Long Strangle is a modification of the long straddle to make it less expensive. The Potential for profit in this strategy is unlimited.
Long Strangle less expensive because of the gap between the strike prices of the call and put options, the movement in the price has to be big enough to bring profit.
The loss occurs when there is no or very less volatility. the profit occurs when there is high volatility, as expected, and the price of the underlying only has to move beyond the call and put strike prices to start giving profits.
What should be the strangle strategy timing ?
The perfect time to use a long strangle is when the market is expected to show high volatility in the near future due to an expected event or news.
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In this case if high volatility is expected in near future then trader buy a slightly “out of money” put option at a lower strike price and buy a call option slightly “out of money” at a higher strike price.
If the price of underlying strike goes above the call strike price then call option gets exercised and brings in unlimited profit, and if the price of underlying strike falls below the put strike price then put option gets exercised and will pay unlimited profit.
However, if there is no big movement in and the price remains within two strike price range then strategy will incur a loss.
Risk potential in the long strangle is limited, it can be a maximum of the sum of the two premiums paid. The situation for maximum loss occurs when the price remains between the strike prices of call and put.
What is ITM , ATM and OTM in option chain ?
In The Money ( ITM ) : Strike price that already suppresses by the current market price.
- A Call option is in ITM when the strike price is less than the current spot price.
- A Put option is in ITM when the strike price is greater than the current spot price.
At The Money ( ATM ) : Current market or spot price of the stock in option.
Out Of Money ( OTM ) : Future strike price, which has only intrinsic value
- A Call option is in OTM when the strike price is greater than the current spot price.
- A Put option is in OTM when the strike price is less than the current spot price.
Long strangle spread explanation with example :
Making long strangle of Stock XYZ having CMP Rs. 300 Buy OTM option Put of strike price 200, Premium paid ➨ Rs. 10
Buy OTM option Call of strike price 400, Premium paid ➨ Rs. 15
Total premium paid ➨Rs. 25
There would be 2 possible cases along-with loss and profit –
- Both (Call/Put) expires within the range of spread ( 200 – 400 ) ➨ The Premium amount paid will be a maximum loss.
- Or both will expire out of spread (200 – 400).
- Unlimited profit will be incurred if the strike price goes up from 425 (strike price 400 + premium paid rs. 25 )
- Unlimited profit will be incurred if the strike price goes down from 175 (strike price 200 – premium paid rs. 25).
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