What is a Strangle Option?
A strangle option is an options trading strategy where the investor holds both a call and put option with different strike prices, but the same expiration date. A strangle option is a useful strategy to use when the trader believes there will be a major price movement in the underlying asset but are unsure in which direction it will move. This strategy gives them leverage in the case of a move up or down. However, the downside to this is the strategy is only profitable if there is a major price movement. If there is only a small move this strategy becomes a loss.
How Does a Strangle Option Work?
Strangle options come in two forms, a long strangle, which is the more popular version, and a short strangle. They both involve the same principle of the trader holding both a call and a put option at different strike prices but with the same expiration date.
Long Strangle Option
To execute a long strangle option, the investor will buy an out-of-the-money call and out-of-the-money put option at the same time. In this scenario, the purchased call option will have a higher strike price than the current market price of the asset or contract in question. On the other hand, the purchased put option will have a lower strike price than the current market price of the asset or contract. The reason this strategy is more popular is due to the profit potential it provides. This strategy provides a theoretically unlimited profit potential on the call option side if the current market price makes a major swing upside. The put option can also profit if the current price makes a major drop. The only risk on this trade is the premium you are paying for the two options.
Short Strangle Option
The less popular of the two strangle options strategies is the short strangle option. In this scenario, the investor will sell an out-of-the-money put and an out-of-the-money call. This strategy limits the traders profit potential because of its inherent neutrality. The only way to profit in this scenario is if the asset’s current market price moves minorly in between the strikeprices of the call and the put. Because of this it limits your max profit the to the total amount of premium you paid for the two options.
Strangle vs. Straddle Options
Strangle and straddle options are both similar in that they are an options strategy where the investor purchases an equal amount of call and put options and aims to profit from a major move in the assets underlying current market price. However, the difference between the two is that in a strangle option the call and put options have different strikeprices, while in a straddle option the strikeprices of the call and put option are the same.
For a more detailed breakdown of straddle options, be sure to visit our straddle options page.