A:

Straddles and strangles are both options strategies that allow an investor to gain from 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 difference is that the strangle has two different strike prices, while the straddle has a common strike price.

Let's say a company is scheduled to release its latest earnings 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 move sharply higher or lower.

Let's assume the stock is trading at $15 in the month of April. Suppose a $15 call option for June has a price of $2, while the price of the $15 put option for June is $1. A straddle is achieved by buying both the call and the put for a total of $300: ($2 + $1) x 100 shares per option contract = $300. The straddle will increase in value 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.

While a straddle has no directional bias, 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 a company's results will be positive, meaning you require less downside protection. Instead of buying the put option with the strike price of $15 for $1, maybe you look at buying the $12.50 strike that has a price of $0.25. This would cost less than the straddle and also require less of an upward move for you to break even. Using the lower-strike put option in this strangle will still protect you against extreme downside, while also putting you in a better position to gain from a positive announcement.

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

    Learn the options strategies top traders use to take advantage of the volatility in the financial services sector and the ... Read Answer >>
  2. What is the difference between open interest and volume?

    Learn how to interpret the relationships between price, volume and open interest in the options and futures markets. Read Answer >>
  3. How do I set a strike price for an option?

    Learn about the strike price of an option and how to set a strike price for call and put options depending on risk tolerance ... Read Answer >>
  4. How Do Speculators Profit From Options?

    Options are a risky game, but you can learn speculators' tricks to use them to your advantage. 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

    Straddle Strategy: A Simple Approach to Market Neutral

    Being both short and long has advantages. Find out how to straddle a position to your advantage.
  3. 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.
  4. 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.
  5. Investing

    Scared By ETF Risks? Try Hegding With ETF Options

    With more ETFs to trade, the risks associated with these investments have grown. To mitigate these risks, ETF options are a hedging strategy for traders.
  6. Personal Finance

    Tips for Answering Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of this exam.
  7. Investing

    Why BofA May Outperform JPMorgan, Citigroup

    The options market is bullish on JPMorgan and Citigroup, but is especially keen on Bank of America.
  8. Trading

    A Newbie's Guide to Reading an Options Chain

    Learning to understand the language of options chains will help you become a more effective options trader.
  9. Trading

    Option trading strategies: A guide for beginners

    Options offer alternative strategies for investors to profit from trading underlying securities. Learn about the four basic option strategies for beginners.
  10. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
RELATED TERMS
  1. Strangle

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

    A short straddle is an options strategy comprised of selling ...
  3. Straddle

    An options strategy in which the investor holds a position in ...
  4. Combination

    A combination generally refers to an options trading strategy ...
  5. Form 6781: Gains And Losses From Section 1256 Contracts And Straddles

    A tax form distributed by the Internal Revenue Service (IRS) ...
  6. Iron Butterfly

    An iron butterfly is a options strategy created with four options ...
Hot Definitions
  1. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  2. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  3. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  4. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  5. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
  6. Cash Conversion Cycle - CCC

    Cash conversion cycle (CCC) is a metric that expresses the length of time, in days, that it takes for a company to convert ...
Trading Center