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The Long Strangle, sometimes called the Buy Strangle or Option Strangle, is a neutral approach wherein you buy Slightly OTM Put Options and simultaneously acquire Slightly OTM Call Options that possess identical underlying assets and expiry dates.
This long-string strategy could be used when the trader expects considerable volatility in the primary stock soon. It is a method that has low risk and could bring a high payoff. There could be a significant movement either upward or downward of the underlying at expiration time. Then, the maximum loss will equal the net premium paid, while maximum profit occurs if there’s significant upward or downward movement. Here is a complete into the long strangle meaning.
What is a long strangle?
A Long Strangle strategy, like a Long Straddle, is among the most basic trading strategies. It’s helpful for making a profit in a highly volatile market. A Long Strangle changes things slightly from a Long Straddle because both calls and puts are Out-the-Money (OTM), so executing this method can be less expensive. When the price of an underlying security moves significantly in any direction, it can produce good returns. It suggests that you don’t need to predict the market’s direction. Instead, you must anticipate its volatility.
Let’s illustrate with a long strangle example:
Bank Nifty trades at 43103. We select a Call option with a 43200 strike and a Put option with a 43000 strike. Each option costs Rs 226 and Rs 189.2 respectively. Both options expire on 08 DEC 2022. With a lot size of 25, the Call option costs Rs 5650 (226 X 25), and the Put option costs Rs 4,730 (189.2 X 25), totalling Rs 10,380. This represents the maximum potential loss. Holding a long options position offers unlimited profit potential, but OTM options require significant underlying movement for profit. Despite unlimited profit potential, the probability of profit in this scenario is only 46.75%.
When to initiate a Long Strangle?
If you think that basic security is going to “make a move” due to events like budget, monetary policy, earning announcements, etc., then you can buy an OTM call and put option. It’s called the Long Strangle strategy.
How do you construct a long strangle option strategy?
You may ask when to use long strangle strategy. Long Strangle involves buying an Out-the-Money (OTM) call option and simultaneously purchasing an OTM put option for the identical underlying security with a matching expiry. The strike price is flexible according to the trader’s preference, but it’s necessary for both call and put strikes to be equidistant from the spot price.
| Strategy | Buy OTM Call and Buy OTM Put |
| Market Outlook | Significant volatility in underlying movement |
| Motive | Capture a quick increase in implied volatility/ big move in underlying assets |
| Upper Breakeven | The strike price of Long call + Net Premium Paid |
| Lower Breakeven | The strike price of Long put – Net Premium Paid |
| Risk | Limited to Net premium paid |
| Reward | Unlimited |
| Margin required | Limited to the premium paid |
Components of a Long Strangle Option Strategy
Here are some of the significant characteristics of the long strangle option strategy:
1) Profits and Losses from the Strategy
For the long strangle to be successful, a significant increase in the volatility of underlying shares or an abrupt change in share price must exist. Profits will be generated near expiry if the share price has moved beyond the strike price of either option enough to cover the premium paid. Like with long straddles, early profits can also be taken in the life of strategy if the share price has moved significantly.
2) Long Strangle Time Decay
Temporal decay is present in the long strangle, just like it is in the long straddle. Both alternatives are worthless (out of money) and therefore have no cash value. As the expiry date gets closer, time passes more swiftly. As a result, the strangle is usually undone well before death.
3) Volatility
The strangle is cheaper compared to the straddle because it’s made up of out-of-the-money options. The issue here is that this plan will only make a profit if the stock price keeps going up more. An investor needs a forecast for a big move to consider a long strangle. If there is no volatility increase or share price change as expected, both alternatives will lose their value.
4) Breakeven
Two breakeven points exist:
- Total premium paid + Long call option strike price = Upper breakeven point
- Total Premium Paid – Long Put Option Strike Price = Lower breakeven point
5) Exit of the Long Strangle
The long strangle strategy is looking to make money from a significant rise in stock price, implied volatility or both. You finish this plan by selling to close the two long options contracts if the underlying asset moves enough before expiration or if there’s an increase in implied volatility. The total profit or loss on your trade would be what you gain from selling premiums minus what it costs to buy them initially. Usually, when to use long strangle strategy are left before their expiration date because the investor wishes to sell the options when they possess significant worth.
Benefits of the long strangle
The Long Strangle option strategy benefits traders, making it an essential instrument for dealing with unstable markets and reducing risk involvement.
- High Return Potential: One of the main advantages is its potential to give high returns. In situations where the primary asset shows significant price changes, Long Strangle allows traders to earn from movements in prices upwards or downwards. By buying out-of-the-money calls and putting options, traders are able to gain benefits no matter which way the market goes.
- Cost-Efficient Strategy and Limited Risk Exposure: While other strategies have significant initial expenses, like purchasing in-the-money options, Long Strangle buys out-of-the-money options at a cheaper rate. This restricts the possible loss to just the premium paid for both choices. Also, the danger is defined and understood beforehand, which gives traders a clear idea of how much they may lose.
- Beneficial in Market Uncertainty: It is particularly advantageous in situations of market uncertainty. In times of economic instability, when the market is known for its ups and downs, the Long Strangle strategy enables traders to exploit greater volatility. It can handle unexpected price changes and provides potential for large profits when the market gets turbulent.
Long straddle vs long strangle
Take a look at the difference between long straddle vs long strangle below:
| Aspect | Long Straddle | Long Strangle |
| Strategy | Involves buying a call and a put option with the same strike price and expiration date. | Involves buying a call and a put option with different strike prices but the same expiration date. |
| Strike Prices | Both options have the same strike price. | Options have different strike prices. |
| Risk | Higher initial investment due to purchasing options at the same strike price. | Lower initial investment as options are purchased at different strike prices. |
| Breakeven | Movement required in either direction to surpass the combined cost of both options. | Movement required in either direction to surpass the combined cost of both options. |
Conclusion
Following straddles, it seems long straddle short strangle are next in popularity. Surprisingly, retail traders like strangles more than straddles because they can play with smaller premiums by choosing deep OTM option strikes. Professional traders prefer the short straddle over the long one, as selling options are more likely to succeed.
FAQs
Long strangles are a type of neutral options strategy. Traders usually employ this when they anticipate a significant market shift but are unsure about its direction. However, in long strangles, there exist two long options, so the stock that underlies must undergo marked price alteration to go above or below points where one breaks even.
You might purchase a long strangle when you anticipate a significant price movement in any direction. For instance, if you think that the stock’s price could increase or decrease considerably after an announcement of earnings, then it is possible for you to buy a strangle and make a profit from the upcoming move. Yet, one should always remember about IV crush when they are buying options before significant market happenings.
For a long strangle to reach breakeven at its expiration, the underlying stock’s price needs to go higher than the call strike or lower than the put strike. The movement of a stock needs to be above or below the calls, and strike prices should be set by an amount equal to the total premium paid initially when creating this strategy.