Straddle and strangle are two options trading strategies. These are volatility strategies. Traders can make profits with these strategies regardless of the market price movement direction. However, both strategies involve significant risks and sophisticated skills to implement correctly.
Straddle
A straddle is a trading strategy in which a trader holds both put and call options. The options should come with the same strike price, same expiration date, and of the same asset class.
A trader can take a long straddle or a short straddle position. A long straddle is a less risky option than a short straddle.
Strangle
In a strangle, a trader holds both put and call options too. The strike prices for these options should be different and the expiry date should be the same.
A trader can take a long or short position with strangle trading strategy too.
How Does a Straddle Work?
A trader will need to hold a put and call options “at-the-money”. It means the market prices of the underlying stock and the option price should be identical. Also, the strike prices for put and call options should be the same with the same expiration date.
A trader can make profits with a straddle if the market prices move beyond the break-even points of the options. For a straddle to work, the prices must move sharply. Hence, the straddle strategy is useful if traders can anticipate sudden market news or market volatility.
Much like options trading, a trader can take a long or short position with straddles. A short straddle will work if there is not enough volatility in the price movement. A trader will make a profit as long as the prices remain between the break-even points.
A long straddle is buying a put and a call option simultaneously. It best works if the underlying asset sees significant price movement. The trader will make profits if the prices move beyond the break-even points as long as they cover the cost of trading a straddle.
Example of Straddle
Suppose the Google Share is trading at $50. A trader will need to buy a put and call option of $50. If the premium for both options is $2 each, the total cost of the contract would be $400 ($ 2+2) * 100 per contract. The trader will make profits as long as the prices move more than $4 in either direction. The break-even points in this scenario are $46 and $54.
How Does a Strangle Works?
A strangle works when a trader holds options that are “out-of-money”. A trader must take a put and a call option but with different strike prices unlike, a straddle. The expiration date of both options should be the same. A trader can take a long or short strangle position.
In a long strangle, the call option’s strike price should be higher than the market price of the asset. And the put option’s strike price should be lower than the current market price of the asset. In a long strangle, the trader makes a profit as long as the asset’s prices move beyond the break-even points. The total loss is limited to the premium paid on both options combined.
In a short strangle, a trader sells a put and a call option that are “out-of-the-money”. It is suited for a trading situation if the asset’s prices do not fluctuate much. The profit is lower in a short strangle than in a long strangle.
Example of Strangle
Suppose the Google Stock is trading at $50. A trader takes a long strangle strategy and buys a call option at $55 with a $3 premium. The long call has a price of $45 and a premium of $2. Hence, the total premium cost is $5 for a contract of 100 shares (total cost is $500).
Scenario 1: Suppose the prices of the Google stock stays between $45-$55. Both Options remain worthless and the trader will incur a loss of $500 (premium paid for both options).
Scenario 2: Suppose Google Share price moves beyond the call strike and is trading at $65. The put option is now expired. The call option brings a profit of $10 per share that equals $1,000. Less the premium cost of $500. Hence, the trader makes a profit of $500.
Scenario 3: Suppose Google Share price falls to $ 40. Now the call option expires. The put option can yield a profit of $5 per share, a total of $500. That makes the total of no profit no loss, as the profit offsets against the premium cost of $500.
Straddle Vs Strangle – Key Differences between a Straddle and Strangle
As we have seen both strategies can work in volatile market conditions. However, the key to success is the anticipation of market movement. A trader can go against the market or financial experts to make profits with a straddle or a strangle.
Both are options trading strategies with similar features, however, there are some key differences in both strategies.
| Feature | Straddle | Strangle |
|---|---|---|
| Cost | Cost is higher | Cost is lower |
| Price movement | Can work with movement in either direction | Best works if price move is anticipated correctly |
| Strategy Position | “At-the-money” | “Out-of-the-money” |
| Strike Price of both Options | Must be the same | Must be different for call and put options |
| Expiry date of both Options Contracts | Must be the Same | Must be the Same |
| Overall risk | Less risky | More Risky |
