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Long Strangle

The Setup

  • Buy a put, strike price A
  • Buy a call, strike price B
  • Generally, the stock price will be between strikes A and B

NOTE: Both options have the same expiration month.

Who Should Run It

Veterans and higher

NOTE: Like the long straddle, this seems like a fairly simple strategy. However, it is not suited for all investors. To profit from a long strangle, you’ll require fairly advanced forecasting ability.

When to Run It

You’re anticipating a swing in stock price, but you’re not sure which direction it will go.

The Sweet Spot

The stock shoots to the moon, or goes straight down the toilet.



About the Security

Options are contracts which control underlying assets, oftentimes stock. It is possible to buy (own or long) or sell (“write” or short) an option to initiate a position. Options are traded through a broker, like TradeKing, who charges a commission when buying or selling option contracts.

Options: The Basics is a great place to start when learning about options. Before trading options carefully consider your objectives, the risks, transaction costs and fees.

The Strategy

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.

Implied Volatility

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.

Options Guy's Tips

  • Many investors who use the long strangle will look for major news events that may cause the stock to make an abnormally large move. For example, they’ll consider running this strategy prior to an earnings announcement that might send the stock in either direction.
  • Unless you’re dead certain the stock is going to make a very large move, you may wish to consider running a long straddle instead of a long strangle. Although a straddle costs more to run, the stock won’t have to make such a large move to reach your break-even points.


Tools

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