A strangle is a strategy involving the simultaneous purchase of a put option and a call option on the same underlying asset. This strategy is used when the trader expects the asset’s price to move significantly but is unsure of the direction in which it will move.
The key to successful strangle trading is timing. You must buy the options before the underlying asset price starts to move, and you must sell them before the expiration date. If timed correctly, this strategy can be profitable even if the asset’s price only moves a small amount.
Reasons to sell strangles
If they correctly predict the direction of price movement
If the magnitude of the price movement is not as anticipated, selling the strangle early will allow them to lock in some profit.
The volatility of the underlying asset decreases
If the underlying asset stabilises in price movements, the price of the put and call options will fall, so selling the strange will allow the trader to make a profit.
Reasons to buy strangles
To utilise a decrease in implied volatility
Suppose the trader expects the underlying asset price to remain relatively stable. In that case, they can buy a strangle and sell it at a higher price when the implied volatility decreases.
To take advantage of an increase in implied volatility
If the trader expects the underlying asset price to move significantly, they can buy a strangle and sell it at a higher price when the implied volatility increases.
To take advantage of time decay
Theta is the rate at which the value of an option declines as time passes. When buying a strangle, the trader takes a position that benefits from time decay.
When and how to buy a strangle
Choose the underlying asset
The first step is choosing the underlying asset you want to trade. It would be best to consider factors such as the price of the asset, its volatility, and the options’ expiration date.
Choose the expiration date
The next step is to choose the expiration date of the options. You should choose an expiration date at least a month away so that there is enough time for the asset’s price to move.
Buy a put option
The third step is to buy a put option with a strike price below the underlying asset’s current price.
Buy a call option
The fourth step is to buy a call option with a strike price above the underlying asset’s current price.
When and how to sell a strangle
Monitor the price of the underlying asset
The first step is to monitor the price of the underlying asset. Before selling the strangle, you should wait for the price to start moving in either direction.
Choose the expiration date
The next step is to choose the expiration date of the options. You should choose an expiration date at least a month away so that there is enough time for the asset’s price to move.
Sell the put option
The third step is to sell the put option with a strike price below the underlying asset’s current price.
Sell the call option
The fourth step is to sell the call option with a strike price above the underlying asset’s current price.
Advantages of using strangle as a strategy
You can make money even if you don’t know which way the market will move
The beauty of this strategy is that you can make money even if you don’t know which way the market will move. All you need is for the market to move enough so that the put or call option expires in the money.
Limited risk
Another advantage of it is that it has limited risk. The most you can lose is the premium you paid for the options.
Opportunities in both rising and falling markets
This strategy also provides opportunities in both rising and falling markets. If you think a market is about to fall, you can sell a put option. If you think a market is about to rise, you can sell a call option.
You can sign up for a free trial to start trading options here with a demo account and test out trading strategies as appropriate.
