What is a 'Strangle'
A strangle is an options strategy where the investor holds a position in both a call and put with different strike prices but with the same maturity and underlying asset. This option strategy is profitable only if there are large movements in the price of the underlying asset. This is a good strategy if you think there will be a large price movement in the near future but are unsure of which way that price movement will be.
BREAKING DOWN 'Strangle'The long strangle strategy involves simultaneously buying an out-of-the-money call and an out-of-the-money put option. A long strangle theoretically has an unlimited profit potential because it involves purchasing a call option. Conversely, a short strangle is a neutral strategy and has limited profit potential. The maximum profit that could be achieved by a short strangle is equivalent to the net premium received less any trading costs. The short strangle involves selling an out-of-the-money call and an out-of-the-money put option.
Difference Between Strangle and Straddle
Long strangles and long straddles are similar options strategies that allow investors to gain from large potential moves to the upside or downside. However, a long straddle involves simultaneously purchasing an at-the-money call and an in-the-money put option. A short straddle is similar to a short strangle and has a limited maximum profit potential that is equivalent to the premium collected from writing the at-the-money call and put options. Therefore, a strangle is generally less expensive than a straddle as the contracts are purchased out of the money.
For example, imagine a stock currently trading at $50 a share. To employ the strangle option strategy, a trader enters into two option positions, one call and one put. Say the call is for $55 and costs $300 ($3.00 per option x 100 shares) and the put is for $45 and costs $285 ($2.85 per option x 100 shares). If the price of the stock stays between $45 and $55 over the life of the option, the loss to the trader will be $585 (total cost of the two option contracts). The trader will make money if the price of the stock starts to move outside the range. Say that the price of the stock ends up at $35. The call option will expire worthless, and the loss will be $300 to the trader. The put option, however, has gained considerable value, and it is worth $715 ($1,000 less the initial option value of $285). Therefore, the total gain the trader has made is $415.