The long strangle, also known as buy strangle or
simply "strangle", is a neutral strategy in options trading that
involve the simultaneous buying of a slightly out-of-the-money put and a
slightly out-of-the-money call of the same underlying stock and expiration
date.
Long Strangle Construction
|
Buy 1 OTM Call
Buy 1 OTM Put |
The
long options strangle is an unlimited profit, limited risk strategy that is
taken when the options trader thinks that the underlying stock will experience
significant volatility in the near term. Long strangles is debit spreads as a
net debit is taken to enter the trade.
Unlimited Profit
Potential
A large gain for the long strangle option
strategy is attainable when the underlying stock price makes a very strong move
either upwards or downwards at expiration.
The
formula for calculating profit is given below:
- Maximum
Profit = Unlimited
- Profit
Achieved When Price of Underlying > Strike Price of Long Call + Net
Premium Paid OR Price of Underlying < Strike Price of Long Put - Net
Premium Paid
- Profit =
Price of Underlying - Strike Price of Long Call - Net Premium Paid OR
Strike Price of Long Put - Price of Underlying - Net Premium Paid
Long Strangle Payoff Diagram
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Limited Risk
Maximum loss for the long strangles options
strategy is hit when the underlying stock price on expiration date is trading
between the strike prices of the options bought. At this price, both options
expire worthless and the options trader loses the entire initial debit taken to
enter the trade.
The
formula for calculating maximum loss is given below:
- Max Loss =
Net Premium Paid + Commissions Paid
- Max Loss
Occurs When Price of Underlying is in between Strike Price of Long Call
and Strike Price of Long Put
Breakeven Point(s)
There are 2 break-even points for the long
strangle position. The breakeven points can be calculated using the following
formulae.
- Upper
Breakeven Point = Strike Price of Long Call + Net Premium Paid
- Lower
Breakeven Point = Strike Price of Long Put - Net Premium Paid
Example
Suppose XYZ stock is trading at Rs40 in June. An options trader executes a long strangle by buying a JUL 35 put for Rs100 and a JUL 45 call for Rs100. The net debit taken to enter the trade is Rs200, which is also his maximum possible loss.If XYZ stock rallies and is trading at Rs50 on expiration in July, the JUL 35 put will expire worthless but the JUL 45 call expires in the money and has an intrinsic value of Rs500. Subtracting the initial debit of Rs200, the options trader's profit comes to Rs300.
On expiration in July, if XYZ stock is still trading at Rs40, both the JUL 35 put and the JUL 45 call expire worthless and the options trader suffers a maximum loss which is equal to the initial debit of Rs200 taken to enter the trade.
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