Stop the Struggle with the Strangle Trading Strategy

If you have been trading Options such as the Call Option or Put Option, you are probably looking for a more challenging and profitable strategy to enhance your trading skills.

Well you’re in luck!

Today, I am going to show you a strategy related to Calls and Puts that can give you access to maximum profits during periods of high volatility, the Strangle trading strategy.

Since you are most likely already trading Options you should be familiar with the term”Out of the Money”, which we will use for the strangles trading strategy.

For those that aren’t as well versed in options trading just yet you can check out my beginners guide here.

Let’s do a quick vocab review:

Strike price – a price of the share agreed and exercised between the buyer and the seller

Market price – current price of the share in the stock market

Option premium – price you paid just like a reservation to buy an apartment or a house. Its purpose is to not let others have a chance to buy the whole strike price first.

What is the Strangles Trading Strategy?

Strangles Trading is an Options trading where an investor will use a Out of The Money Call option and a Out of the Money Put option with option premiums to purchase or sell an underlying asset (must be same ratio, 1,000 shares of Call:1,000 shares of Put or 3,000 shares of Call:3,000 shares of Put) at Strike Prices on the SAME expiration date or same future agreed date.

In this strategy, the Call Option’s strike price should be higher than the Put Option’s strike price. It is like a tug of war between these two options and between profit and loss.

Just for the recap, Out of the Money means you will pay money doing the following:

Call option (you are the one who paid the option premium to buy the share)

You will lose the option premium money and lose the opportunity to earn profit when the strike price (SP) is still higher than the market price (MP) on the expiration date

Out of the Money Call option = SP > MP

Put option (you will pay the option premium to sell the share at a strike price, but you don’t have an obligation to buy the share on the expiration date)

It is the opposite. You will lose the option premium money you paid. The strike price is lower than the market price on the expiration date.

Out of the Money Put Option = SP < MP

Yes, you might think that trading with these two options at the same time isn’t safe or can be dangerous since you are paying premiums for both options.

But that’s necessarily true.

One of the beauties of selling both puts and calls is that only half the trade has to be right.

The profit of one option is beyond the loss from the other option meaning:

If the puts are in trouble, the calls are safe. If the calls are in trouble, the puts are safe.

If you have already done your research and can mostly predict about the movement of market prices.

There are two common strategies of Strangles Trading.

They are the Long Strangle Strategy and the Short Strangle Strategy.

First, let’s breakdown how a Long Strangles trading strategy works.


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How the Long Strangle Strategy works

A Long Strangle strategy should be applied where the market prices will have a drastic change on the same expiration date.

Long Strangles Strategy Example

Let’s assume that today is February 12 and we buy two options that have an expiration date on March 15.

We purchased both of the following:

A Call option: Where the call strike price is $170 and the option premium is $2.50

A Put option: Where the put strike price is $140 and the option premium is $0.50

If you add both premiums, we paid $3.00.

To breakeven, the market price on the expiration date must be:

$173 and above for Call option ($173 = $170+$3)

$137 and below for Put option ($137 = $140-$3)

So to reiterate, breakeven is at either $137 for the put or $173 for the call.

Strangle Trading Strategy

Notice how the example graph above looks like a tug of war.

When the March 15 expiration date came around the market price is at $178.65.

This means that our put was a dud and it expires worthless, but we earned a profit on the Call option.

Check out the chart below:

Strangle Trading Strategy

Here’s how much you will make:

Profit: $178.65 – $170 = $8.65

Put option premium of $2.50 + Call option premium of $0.50 = $3

Net profit = $8.65 – $3 = $5.65

Let’s take a look at some other scenario’s that could potentially have played out:

Another Scenario 1: If the Market price is $132

This means you will earn a profit from the Put option.

The more shares you paid for, the more profits you’ll gain.

Profit: $140 – $132 = $8.00

Put option premium of $2.50 + Call option premium of $0.50 = $3.00

Net profit = $8 – $3 = $5.00

Another Scenario 2: If the Market price is almost the same as Call strike price

Let’s say that the market price, at the expiration date, is $172.

Profit: $172 – $170 = $2 

Put option premium of $2.50 + Call option premium of $0.50 = $3.00

$2 – $3 = -$1

You have two options here

  1. You let the Option contract expire worthless. You will lose the premium of $3.00 not $1.00 because you were not obliged to buy the shares.  You would pick this option if you expect the stock’s price to fall.
  2. You buy the shares and have a loss of $1/share.  You would pick this option if you expect the price to continue to rise.

Scenario 3: Market price is almost same or same as Put strike price

You will lose $3.00 (premiums you paid) and the Options become worthless.

The not so good news for Long Strangles:

If the market price is not moving much, you will lose the option premiums.

During a neutral/stagnant market this is not the strategy that you want to employ.

 

The good news for Long Strangles:

UNLIMITED PROFIT if the market price has dramatic change in either direction, your profit on one option will significantly get higher than the loss on the other option and the paid premiums combined.

Also, LIMITED LOSS since the maximum loss you can get is the option premiums you paid because you are not obliged to buy the shares on the Put and Call options.

In Long Strangles, the potential profit you will earn is much higher than the potential loss.

Just be careful when predicting the market price on the expiration date.

What’s the difference between Strangles and Straddles Trading?

Straddles use the same Strike price while Strangles use different Strike prices.

How Short Strangles Strategy works

If you are still confused whether you should use the Long Strangles trading strategy or not, try this short one first. You do not need to do as deep of an analysis on whether the market price will go down or up.

A Short Strangles strategy is is an Options trading where an underlying asset is being sold with the assumption that there will be just a little movement in market price on the same expiration date.

Same as the long straddle, the Call strike price should be higher than the Put Option strike price.

This is perfect if you think market prices will stay the same or almost the same.

The not so good news for Short Strangles:

  1. There’s unlimited loss potential.
  2. There’s limited profit potential since you will gain only the net option premiums paid to you.

The good news for Short Strangles:

SURE amount of PROFIT if the market price has no dramatic change and within the breakeven.

It’s a safe way to invest within a short time period.

Recap:

A Long Strangles strategy should be applied where the market prices will have a drastic change on the same expiration date. Short Strangles, should be applied where the market prices will have a little change on the same expiration date

Short Strangles example

Suppose today is March 2nd and I sell 2 options contracts with the expiration date of March 15th.

We sell:

Call option: When the call strike price is $177 and the option premium is $0.50

Put option: When the put strike price is $175 and the option premium is $2.50

If you add both premiums, you get paid $3.00/share.

Short Strangles

So breakeven must be at  $172 for the put and at $180 for the call:

($180 = $177 Call Option strike price +$3)

($172 = $175 Put Option strike price -$3)

The sure thing is, you already earned premium of $3.

The March 15 expiration date comes and the market share is $178.65.

This means you can still earn a bit from Call Option ($178.65 is more than $175 Put Strike price) if the investor who paid the premium still decided to buy your shares.. Here’s how much you can get:

Profit from per share value: $180 (Call Strike price) – 178.65 = $1.35      

Put option premium of $2.50 + Call option premium of $0.50 = $3 premium collected

Net profit = $1.35 + $3 = $4.35

Another Scenario 1: Market price is $172

You will earn a $3 premium.

Because if you compute it, you will not get a gain or loss in buying the shares.

If you will buy the shares, the investor will sell the shares to you again at $175 Put option Strike price ($172 – $175 = -$3). $3 premium collected + -$3 on share loss, the answer will be 0. Just a breakeven.

Another Scenario 2: Market price is $181

You will earn $3 premium collected.

If you proceed to sell the shares to the investors at $180 Call option Strike price ($180 – $181 = -$1). Selling stocks below the market share price will not gain a profit.

Another Scenario 3: Market price is $176

Profit from Call option: $177 – $176 = $1  

Put option premium of $2.50 + Call option premium of $0.50 = $3 premium collected

Net profit = $1 + $3 = $4

Another Scenario 4: Market price is $180

You will earn $3 premium collected.

Because if you compute it, you will not get a gain or loss in selling the shares.

If you proceed to sell the shares to the investors at $180 Call option Strike price ($180 – $180 = 0).

Conclusion

The stock became 178.66 at the time of the screen capture.

Let’s just imagine that the market price is still 178.65 instead of 178.66

Strangle Trading Strategy

By the curves, you will see the difference between the distance of long strangle break even and short strange breakeven.

The Long Strangles sample illustration earlier shows that the breakeven was used to show that you can earn unlimited profits if the Put is below $137 and if the Call is above $173

The Short Strangles illustration earlier shows that the the breakeven was used to show that you can earn the combined Option premiums and it depends on the Market price if you will sell or buy the shares to gain profit.

With the right prediction, you will earn profits and minimize your losses rather than just simply buying low and selling high market shares.

Try out this Strangles Trading Strategy and let me know how it works for you.

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