Using Option Strangle Strategies
An option strangle strategy takes place when an investor holds positions in both a call and a put of an underlying stock. Both the call and the put will have the same expiration date, yet they will have differing strike prices.
Investors use this type of strategy when they feel that there will be a large price movement in the underlying stock, however they are unsure of whether that stock price will move upwards or downwards. Option strangle strategies consist of both long and short versions.
The Long Strangle Option
An investor using a long strangle option strategy will purchase both a call and a put having different strike prices and the same expiration dates. In most cases, the call that is purchased will have a higher strike price and the put will have a lower strike price. Both the call and the put that are purchased are both slightly out-of-the-money.
Investors using this strategy essentially have an unlimited profit potential and very large gains may be experienced when the price of the underlying stock makes a very significant move either upwards or downwards at the expiration time.
The investor will conversely experience the maximum loss if the price of the underlying stock is trading between the strike prices of the call and the put options that were purchased. In this case, both of the options will expire worthless and the investor will lose the amount of the initial debit that was taken when they entered into the trade.
The Short Strangle Option
The short strangle strategy is converse to the long strangle strategy. Investors will enter into a short strangle strategy when they expect there to be very little movement in the price of the underlying stock.
This strategy involves the simultaneous selling of both a call and a put on an underlying stock, both of which are slightly out-of-the-money. Both the call and the put will have the same expiration date.
Unlike the long strangle option strategy, the short strangle option strategy has only limited profit potential. An investor will achieve the maximum profit when the price of the underlying stock is trading between the strike prices of the put and the call on the expiration date. On this date and at the price of the underlying stock, the options will expire worthless, allowing the investor to keep all of the initial credit they were given when shorting the call and the put options.
The short strangle option, however, does have a large amount of risk associated with it. This can be experienced by the investor when the price of the underlying stock makes a large move either up or down at the time of expiration.
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