A:

Straddles and strangles are both options strategies that allow the investor to gain on significant moves either up or down in a stock's price. Both strategies consist of buying an equal number of call and put options with the same expiration date; the only difference is that the strangle has two different strike prices, while the straddle has one common strike price.

For example, let's say you believe your favorite diamond mining company is going to release its latest results in three weeks time, but you have no idea whether the news will be good or bad. This would be a good time to enter into a straddle, because when the results are released the stock is likely to be more sharply higher or lower.

Let's assume the price is currently at $15 and we are currently in April 05. Suppose the price of the $15 call option for June 05 has a price of $2. The price of the $15 put option for June 05 has a price of $1. A straddle is achieved by buying both the call and the put for a total of $300: ($2 + $1) x 100 = 300. The investor in this situation will gain if the stock moves higher (because of the long call option) or if the stock goes lower (because of the long put option). Profits will be realized as long as the price of the stock moves by more than $3 per share in either direction. A strangle is used when the investor believes the stock has a better chance of moving in a certain direction, but would still like to be protected in the case of a negative move.

For example, let's say you believe the mining results will be positive, meaning you require less downside protection. Instead of buying the put option with the strike price of $15, maybe you should look at buying the $12.50 strike that has a price of $0.25. In this case, buying this put option will lower the cost of the strategy and will also require less of an upward move for you to break even. Using the put option in this strangle will still protect the extreme downside, while putting you, the investor, in a better position to gain from a positive announcement.

(For further reading, see Risk Graphs: Visualizing Your Profit Potential.)

RELATED FAQS
  1. What options strategies are best suited for investing in the aerospace sector?

    Learn how investors profit from volatility in the aerospace sector by employing options strategies, which include the long ... Read Answer >>
  2. What options strategies are best suited for investing in the oil & gas drilling sector?

    Invest in the oil and gas drilling sector with confidence by employing one of several winning options strategies that work ... Read Answer >>
  3. When is an options straddle deep in the money?

    Learn about options straddle positions, the moneyness of straddles and when a straddle position is considered to be deep ... Read Answer >>
  4. What options strategies are best suited for investing in the automotive sector?

    Learn how options strategies, such as the long straddle and the long strangle, enable investors to profit no matter which ... Read Answer >>
  5. Under what circumstances should I pursue a straddle?

    Learn what a straddle is, how a straddle position is created, when you should pursue a long straddle strategy and when to ... Read Answer >>
  6. What kinds of financial instruments can I use a straddle for?

    Learn about options and straddles; discover some examples of optionable assets and how a straddle is used for financial instruments. Read Answer >>
Related Articles
  1. Trading

    Get A Strong Hold On Profit With Strangles

    Forget straddles. These strangles are both liberating and legal in the investing world.
  2. Trading

    Profit From Earnings Surprises With Straddles And Strangles

    These option strategies allow traders to play on earnings announcements without taking a side.
  3. Trading

    Profit On Any Price Change With Long Straddles

    In this strategy, traders cash in when the underlying security rises - and when it falls.
  4. Trading

    Options Strategies That Profit From Rite Aid's Volatility

    Learn why options strategies such as the long straddle and the long strangle enable investors to make big money with Rite Aid and other volatile stocks.
  5. Trading

    The Long Straddle And Price Consolidation

    With options, the direction of a stock's next major move becomes less important than its magnitude.
  6. Trading

    Index Options: A How-To Guide

    Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors.
  7. Trading

    Trading Volatility? Don’t Trade Stocks, Trade Options

    During times of volatility, traders can benefit greatly from trading options rather than stocks. We explain why.
  8. Trading

    How To Use Options To Make Earnings Predictions

    Use this simple three-step process to make your own earnings predictions using options data.
  9. Taxes

    How Are Futures & Options Taxed?

    We present a basic introduction to the US tax processes of futures and options.
RELATED TERMS
  1. Strangle

    An options strategy where the investor holds a position in both ...
  2. Short Straddle

    An options strategy carried out by holding a short position in ...
  3. Long Straddle

    A strategy of trading options whereby the trader will purchase ...
  4. In The Money

    1. For a call option, when the option's strike price is below ...
  5. Out Of The Money - OTM

    A call option with a strike price that is higher than the market ...
  6. Long Put

    An options strategy in which a put option is purchased as a speculative ...
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  3. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  4. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  5. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
  6. Stop Order

    A stop order is an order to buy or sell a security when its price increases past a particular point in order to limit losses ...
Trading Center