The Long Strangle strategy is a method of options trading that gains from large price movements in either direction. It is a strategy of buying two out-of-the-money (OTM) options: a call and a put, both of the same underlying asset and the same expiration date.
How Does a Long Strangle Work?
The trader buys:
- An OTM Call Option (strike price higher than the current market price)
- An OTM Put Option (strike price less than current market price)
Such a strategy is cheaper than a Long Straddle, which takes up at-the-money (ATM) options since OTM options are cheap. The only problem with this strategy is that the stock or index has to undergo a big price fluctuation to gain profits.
Example of a Long Strangle
If the Nifty index is 8200, the trader purchases:
- A 8400 Call (OTM)
- A 8000 Put (OTM)
If the price moves abruptly past either strike owing to volatile prices, the trader stands to make very good profits.
Risk, Reward, and Breakeven Points
- Risk: Restricted to the entire premium paid for both options.
- Reward: Unlimited, depending on how far the price has moved.
- Breakeven Points:
- Upper Breakeven: Call Strike Price + Net Premium Paid
- Lower Breakeven: Put Strike Price – Net Premium Paid
When to Use
A Long Strangle is perfect when one is anticipating high volatility but cannot anticipate the direction.
Conclusion
The Long Strangle strategy presents an inexpensive mechanism for making a profit from price swings with restricted risk and boundless potential earnings. It is a useful mechanism for seasoned speculators in fluctuating markets.