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Strangles

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A strangle is a modified straddle. Straddles utilize options to benefit from a large, or alternatively small, amount of price volatility.

A long strangle is created by purchasing a put and call with the same expiration date with a spread between the put and call’s strike prices: the strike price of the call is higher than the strike price of the put. The underlying price must move above the strike price of the call plus the cost of the premium to earn profit on the high side.

Long Strangle

It must move below the strike price of the put minus the cost of premium to earn a profit on the low side. It is possible for options to be exercised at one end, fall or rise beyond the other end, and be exercised the second time. This maximizes the potential profit from a long strangle, but the internal spread created by differing strike prices means market price has a farther distance to travel. This play requires very high price volatility.

A short strangle is created by writing equal amounts of puts and calls on an underlying asset with the same expiration date. The put and call are written with a spread between strike prices, the call’s strike price is higher than the put’s strike price. The market price must remain within the two strike prices for you to earn your profit. Like a short straddle, if the price rises above or below the strike price it will be exercised against you, creating a loss.

Short Strangle
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Option Profit Diagram Example

  • As you move to the right the underlying asset increases in value. The left side is lower in underlying price, while the right side is higher in underlying price.
  • As you move to the top the trade increases in profit. The gray horizontal line is the profit/loss difference point, the zero line where there is no profit and no loss. Higher above the line is higher in profit, lower below the line is higher in losses.
  • The blue line is the profit/loss at expiration. The purple line is the profit/loss now. Eventually the curving purple line will become the blue line.
  • A flat blue line below the grey zero line indicates limited losses at expiration. A flat blue line above the grey zero line indicates limited gains at expiration. A blue line that slopes down infinitely off the chart represents unlimited losses, while a line that slopes infinitely up represents unlimited gains.
  • A preference for limited loss trades is strongly recommended, remember that an estimated 60% to 70% of retail trader options expire worthless when purchased since prices need a reason to move in the money. If you have limited gains, they should preferably be both more likely than and higher than your potential losses. Always manage risk carefully.
  • Option diagrams created by TDAmeritrade “ThinkOrSwim” platform.