A long strangle gives you the right to sell the stock at strike price A and the right to buy the stock at strike price B.
The goal is to profit if the stock makes a move in either direction. However, buying both a call and a put increases the cost of your position, especially for a volatile stock. So you’ll need a significant price swing just to break even.
The difference between a long strangle and a long straddle is that you separate the strike prices for the two legs of the trade. That reduces the net cost of running this strategy, since the options you buy will be out-of-the-money. The tradeoff is, because you’re dealing with an out-of-the-money call and an out-of-the-money put, the stock will need to move even more significantly before you make a profit.
Maximum Potential Profit
Potential profit is theoretically unlimited if the stock goes up.
If the stock goes down, potential profit may be substantial but limited to strike A minus the net debit paid.
Maximum Potential Loss
Potential losses are limited to the net debit paid.
Break-even at Expiration
There are two break-even points:
- Strike A minus the net debit paid.
- Strike B plus the net debit paid.
TradeKing Margin Requirements
After the trade is paid for, no additional margin is required.
As Time Goes By
For this strategy, effect of time decay is your mortal enemy. It will cause the value of both options to decrease, so it’s working doubly against you.
After the strategy is established, you really want implied volatility to increase. It will increase the value of both options, and it also suggests an increased possibility of a price swing. Sweet.
Conversely, a decrease in implied volatility will be doubly painful because it will work against both options you bought. If you run this strategy, you can really get hurt by a volatility crunch.