Long Strangle

Overview

A strangle is a slight modification to the Straddle to make it cheaper to execute. This strategy involves simultaneous buying of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock/index and expiration date. Here again the investor is directionally neutral but is looking for an increased volatility in the stock/index and the prices moving significantly in either direction. Since OTM options are purchased for both Calls and Puts it makes the cost of executing a Strangle cheaper as compared to a Straddle, where generally ATM strikes are purchased.

Since the initial cost of a strangle is cheaper than a Straddle, the returns could potentially be higher. However, for a Strangle to make money, it would require greater movement on the upside or downside for the stock/index than it would for a straddle. As with a Straddle, the strategy has a limited downside (i.e. the Call and the Put premium) and unlimited upside potential.

When to use: The investor thinks that the underlying stock/index will experience very high levels of volatility in the near term.

Risk: Limited to the initial premium paid

Reward: Unlimited

Breakeven:

  1. Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
  2. Lower Breakeven Point= Strike Price of Long Put—Net Premium Paid

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