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. When is a put option considered to be 'in the money?'

    Learn about put options, how these financial derivatives work, and when put options are considered to be in the money related ... Read Answer >>
  2. What occurs when a security meets its strike price?

    Learn more about the moneyness of stock options and what happens when the underlying security's price reaches the option ... Read Answer >>
  3. Can an Option Have a Negative Strike Price?

    When it comes to exchange traded options, an option can't have a negative strike price. Read Answer >>
  4. Why are options very active when they are at the money?

    Stock options, whether they are put or call options, can become very active when they are at the money. In the money options ... Read Answer >>
Related Articles
  1. Trading

    4 Popular Options Strategies for 2016

    Learn how long straddles, long strangles and vertical debit spreads can help you profit from the volatility that stock analysts expect for 2016.
  2. Trading

    How To Use Options To Make Earnings Predictions

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

    How Are Futures & Options Taxed?

    We present a basic introduction to the US tax processes of futures and options.
  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. Trading

    Beginners Guide To Options Strategies

    Find out four simple ways to profit from call and put options strategies.
  6. Investing

    Why BofA May Outperform JPMorgan, Citigroup

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

    Using Options To Pay Off Debt

    We tell you about four option strategies that could provide a way to pay off your debt.
  8. Investing

    Options Suggest Microsoft Could Be Set To Decline

    Microsoft has been rocking 2017 so far, but the options market has a bearish outlook on the stock.
  9. Investing

    Netflix Shares May Rise 10%, Options Show

    The options market suggests Netflix could top $220 a share by November 17.
  10. 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.
RELATED TERMS
  1. Long Straddle

    A long straddle is an options strategy with the purchase of both ...
  2. Form 6781: Gains And Losses From Section 1256 Contracts And Straddles

    Form 6781 is a tax form distributed by the IRS and used to report ...
  3. Strike Price

    Strike price is the price at which the underlying asset of a ...
  4. Iron Condor

    An iron condor is an options strategy that involves buying and ...
  5. Put Option

    A put options gives the owner the right to sell a specified amount ...
  6. Protective Put

    A protective put is a risk-management strategy that investors ...
Trading Center