Straddle vs. Strangle Options Strategy

Masterworks
February 3, 2023

What is Options Trading?

Options trading is a form of active investing where a trader buys or sells options contracts. Options contracts are agreements that give the holder the right to buy or sell an underlying asset at a specified price (strike price) within a specific time frame. 

  • Call options give the buyer the right to buy an underlying asset at the strike price.
  • Put options give the buyer the right to sell an underlying asset at the strike price.

Options trading can be used for a variety of purposes, including speculation, hedging and income generation. It can be a useful tool for managing risk, as options contracts allow the trader to limit their potential losses.

Useful Options Terminology

  • At-The-Money (ATM): An option is at-the-money when its strike price is the same as the current underlying asset price. This is the same for both calls and puts. 
  • Out-of-The-Money (OTM): A call option is out-of-the-money when its strike price is lower than the current underlying asset price. A put option is OTM if the underlying’s price is above the put’s strike price.
  • In-the-Money (ITM): A call option is in-the-money if the stock price exceeds the strike price. A put option is ITM if the stock price is below the strike price.
  • Implied Volatility: Implied volatility is an estimate of an underlying security’s future volatility as predicted or implied by the option’s price. It is calculated via an option pricing model.

Straddle Trades

An option straddle strategy involves simultaneously buying or selling both a call option and a put option with the same strike price and expiration date.

Long Straddle

A long straddle option is when a trader purchases both a long call and a long for the same underlying asset, with the same strike price and expiration date. 

This is a neutral options strategy because the trader can profit from price movements in either direction, so they are not betting on the direction of the market. Instead, they are expecting significant price movement in either direction, perhaps because an earnings call or some other event is upcoming.

For example, if the underlying stock price is $100 and the trader buys a long call option with a strike price of $100 and a long put option with a strike price of $100, the trader will profit if the stock price makes a large move, regardless of the direction of the move.

However, for the trade to be profitable, the price movement must be substantial enough to offset the combined cost of the call and put options — called the breakeven point.

This cost, known as the option premium, is the price the trader pays for the options and represents the potential payout if the trade is successful.

Short Straddle

A short straddle strategy is when an investor sells both a short call option and a short put option with the same strike price and expiry date.

This is also a neutral strategy, but one where the investor believes the stock price will remain relatively stable. The seller of options would profit when the options expire worthless.

If the stock price moves significantly in either direction, the investor may be forced to buy the options back at a higher price, resulting in a loss. The maximum profit from a short straddle trade is limited to the premium collected from selling the options, whereas the potential loss is unlimited.

Short straddles have limited profit potential and undefined risk. The maximum risk is undefined beyond the position’s breakeven point.

Strangle Trades

An option strangle strategy involves simultaneously buying or selling a call option and a put option with different strike prices but the same expiration date.

Long Strangle

A long strangle option is when a trader buys both a long call and long put option with different strike prices but the same expiration date. 

The goal of this trade is to profit from significant price volatility, but it is not betting on the direction of the move.

In a strangle trade, the trader will typically buy a call option with a higher strike price and a put option with a lower strike price. The idea behind this trade is that if the underlying asset makes a significant move in either direction, one of the options will be profitable.

For example, if a stock is trading at $100 and the trader buys a call option with a strike price of $105 and a put option with a strike price of $95, the trader will profit if the stock moves significantly higher or lower.

Short Strangle

A long strangle is described above, where an investor purchases both a call option and put option with different strike prices.

On the other hand, a short strangle is where an investor sells both a call option and a put option with different strike prices, but the same expiration date.

The goal of this strategy is to profit from the time decay of the options, as well as a stable stock price.

By selling both a call and a put option, the trader collects the premium from both options, but at the same time takes on unlimited potential losses if the stock price moves significantly in either direction.

In a short strangle trade, the call option is sold with a higher strike price and the put option is sold with a lower strike price. This means that if the stock price moves above the strike price of the call option or below the strike price of the put option, the trader may be forced to buy back the options at a higher price, resulting in a loss.

The further out-of-the-money the options are sold, the higher the premium collected, but the greater the potential for loss if the stock price moves significantly.

Straddle vs Strangle Options Trading Strategies

Straddle and strangle options trades are both neutral strategies that aim to profit from significant price movements in either direction, but there are some key differences between the two.

These are called “offsetting positions” because one security is purchased to reduce any risk of loss you may have from holding another position.

  • In a straddle trade, a trader buys both a call option and a put option with the same strike price and expiration date.
  • In a strangle trade, a trader buys both a call option and a put option with different strike prices but the same expiration date.

The key difference between a straddle and a strangle is the strike price of the options.

In a straddle, the strike prices of the call and put options are the same, while in a strangle, the strike prices are different. This difference in strike prices can impact the cost of the options, as well as the potential payout from the trade.

Iron Condor & Iron Butterfly

An iron condor and an iron butterfly are two options trading strategies that involve multiple option positions in order to generate profits from a range-bound market.

Iron Condor Trades

An iron condor is a neutral strategy that involves selling both a call option and a put option with a lower strike price, and then buying both a call option and a put option with a higher strike price. In other words, combining a long straddle and a short straddle. 

The goal of this strategy is to generate a profit from the premiums collected by selling both options, while limiting the potential losses if the stock price moves outside of the range defined by the strike prices of the options. 

The key to success in an iron condor is to select the correct strike prices and to manage the trade effectively if the stock price moves outside of the expected range.

Iron Butterfly Trades

An iron butterfly is similar to an iron condor, but involves selling both a call option and a put option with the same strike price, and then buying both a call option and a put option with different strike prices. In other words, purchasing a long straddle against a short straddle. 

The goal of this strategy is to generate a profit from the premiums collected by selling the options while limiting the potential losses if the stock price moves outside of the range defined by the strike prices of the options. The iron butterfly is generally considered to be a more advanced strategy due to the limited profit potential and greater risk compared to other options trading strategies.

Both iron condor and iron butterfly strategies are considered to be complex options trading strategies that require a solid understanding of options trading and a comfortable risk tolerance. 

Traders who are considering using these investing strategies should have a clear understanding of the potential risks and rewards before entering into any trades.

The Bottom Line

Both straddle and strangle strategies can be useful for traders who believe the price of the underlying security will move significantly but are uncertain of the direction of the movement. However, if the direction of the movement is not significant enough, then a loss will likely be incurred.

Because of the large potential for loss, derivatives trades like straddles and strangles are highly risky if the realized volatility isn’t higher than the implied volatility of the options.

This information in this article is provided for educational purposes only. This information should not form the basis of an investment decision, and should not be construed as investment advice. 


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