A long strangle is an options trading technique in which you buy both a call and a put option with the same expiration date but different strike prices. This approach is employed when an investor anticipates a major price movement in an underlying asset but is unsure about the direction of the movement.
Strategic Overview
- Call Option: The investor purchases a call option with a higher strike price, granting them the right to purchase the underlying asset at that price before expiration. This is utilized to profit on a possible increase in the asset price.
- Put Option: The investor simultaneously acquires a put option with a lower strike price, providing them the opportunity to sell the underlying asset at that price before it expires. This is utilized to profit on a possible drop in the asset’s price.
Profit and loss potential
- Profit: The long strangle strategy makes money when the underlying asset’s price swings dramatically in either direction. On the upside, the profit potential is theoretically unlimited, but on the downside, it is restricted to the difference between the asset’s price and the lower strike price minus the option fee.
- Loss: The maximum potential loss is restricted to the total premiums paid for the call and put options. This occurs when the asset’s price remains between the two strike prices at expiration, making both options worthless.
When To Use
- High Volatility Expectations: Long strangles work best in highly volatile markets, where the investor expects a substantial price movement but is unsure of its direction.
- Earnings Announcements or News Events: Traders may use this technique before to events such as earnings announcements or news releases, when volatility tends to rise.
Risks and Considerations
- Time Decay: Time decay has a negative influence on long strangles since options lose value as they approach expiration. To offset this degradation, a big price movement in the underlying asset must occur very rapidly.
- Volatility Changes: A decrease in volatility can potentially affect the approach by lowering the likelihood of the underlying asset moving significantly in either direction.
Conclusion:
A long strangle is a versatile options strategy ideal for investors who expect a substantial price movement in an underlying asset but are unsure of the direction. While it has the potential to provide significant returns if the market goes in the right direction, traders must be cautious of dangers such as time decay and volatility changes.
