Here is a more definition of a strangle (and a straddle):
To: PAL
From: rydad Thursday, Aug 9, 2001 12:46 PM
Respond to
Here's an article I found on straddles and strangles:
A straddle is an options strategy which involves the purchase of a call and a put with the same
strike price, the same expiration date, and the same underlying security. An example is the
purchase of an XYZ November 95 call and the simultaneous purchase of an XYZ November
95 put while the stock price is about 95.
A strangle is an options strategy which involves the purchase of a call and a put that are both
slightly out of the money and have the same expiration date, and are of the same underlying
security. An example is the purchase of an XYZ November 100 call and the simultaneous
purchase of an XYZ November 90 put while the stock price is about 95. This is sometimes
referred to as a combination.
The investor would use this options strategy if he felt that the underlying security is volatile and is
going to make a large move. However, the investor doesn't know the direction of the move.
An example of the straddle options strategy is as follows: An investor purchases the XYZ
November 95 call for 3 and the XYZ November 95 put for 2-1/2. The maximum possible loss
is the total debit of 5-1/2. If XYZ closes above 100-1/2 at expiration, the investor is holding a
profitable position despite the fact that the put expired worthless. If XYZ closes below 89-1/2
by expiration, the investor is holding a profitable options position despite the fact that the call
expired worthless. If XYZ closes exactly at 95 on expiration day, this is where the maximum
loss occurs. At any other price between 100-3/8 and 89-5/8, the investor realizes a partial loss.
One side of the trade is profitable and the other side is a loss. At 100-1/2 and 89-1/2 the
investor is even (minus commission).
The best time frame to use for this options strategy is between 60 and 90 days. Start with the
assumption that the stock will move up or down commensurate to its volatility within that time.
The entire position should be viewed with respect to how expensive the options are. It is
unlikely the investor will find the calls and puts priced reasonably. More often than not, one side
will be underpriced and the other side will be overpriced. At the time of this writing, most of the
premium is in the calls and the puts have far less premium in them.
The follow up action if the stock moves up or down to the next strike price is quite simple.
Assume we're long the XYZ November 95 straddle. Further assume that the price of XYZ has
moved up to 100. The calls might be worth 7 points and the puts might be worth 1 point now.
There are two courses of action. The first, is to do nothing. Just let the straddle play itself out.
The second is a more attractive alternative. Sell the XYZ November 95 put for 1 point. And
buy the November 100 put for 3-1/2. The net cost of this transaction is 2-1/2 points. Add this
to the original cost of 5-1/2, and the new total cost of the position is 9 points.
The present position is:
Long one XYZ November 95 call at 3
Long one XYZ November 100 put at 2-1/2
Total combined cost is 8 points
Because the put strike is 5 points higher than the call, the worst this position can be at expiration
is 5 points. Should the stock continue to move up, the call will be worth more and more. The
most the investor can lose now is 3 points. He has now improved his risk exposure over the
original position. Additionally, he has not limited his profit potential. If the stock continues to
rise, the position will become profitable; should the stock fall dramatically, the position will
become profitable below 92. And it will, of course, be profitable above 103.
The difference between a straddle and a strangle is the strike price of the options. The strangle
has strikes which are slightly out of the money. Most often, this strategy would be used if XYZ
were trading at about 97. Then the XYZ November 100 calls and the XYZ November 95 puts
would be purchased. The advantage of this strategy is that the potential loss, should XYZ
remain at 97 at expiration, is less than that of a straddle. The disadvantage is that the stock
needs to move even further for the position to become profitable. It could also be done with the
100 calls and the 90 puts if XYZ were at 95. However, despite the fact that this options
strategy might look a lot cheaper than the straddle, it also carries much more risk. |
