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Strangle Option and Straddle Option - A Simple Investment Strategy

Retired from investment banking and teaching, Philip has written several books on investing.

What is a Long Strangle?

Buying a long strangle in effect means that the investor is buying a call option (a call gives the buyer the right but not the obligation to buy the underlying asset on a prearranged date in the future) and a put option (a put gives the buyer the right but not the obligation to sell the underlying asset on a future agreed date) on the same currency or stock in the hope that the market moves sharply in either direction to at least break even on the premium paid for engaging in the strategy. (See below link to currency options trading-pay-off diagrams explained) A long strangle will only lose the investor money if the market does not move significantly in one direction or another and fails to cover the premiums which are the investors initial cost.

Investors who engage in strangle strategies are using this strategy to take advantage of the volatility of a currency or a stock price.

strangle-option-and-straddle-option

Example of a Long Strangle Option

EUR/USD is trading today at 1.4210 so the investor buys two lots of June long calls at a strike price of 1.4200 (out of the money) and pays a premium of 50 pips representing a cost of $100,000x2x0.0050 = $1000 and at the same time buys 2 lots of June long puts at a strike price of 1.4225 (out of the money) and pays a premium of 25 pips representing a cost of 100,000x2x0.0025=$500, so the total cost for the Long strangle strategy is $1,500. This represents the total loss that the investor will incur if the options expire worthless.

The strategy for the investor here is that the options investor expects the EUR/USD to be either bullish or bearish. The investor doesn’t care and will be happy whichever way the currency moves.

A gain however can be made in either direction. If the EUR/USD rises above 1.4275 (strike price plus the combined premiums paid) the investor will allow the put to expire worthless and then the profit from the call is unlimited. However, if the EUR/USD falls below 1.4150 (the put strike price plus the combined premiums paid) the investor will allow the call option to expire and here again the profit potential is unlimited.

If the EUR/USD is at the 1.4200 strike price on expiry the investor will allow the call option to expire and exercise the put option thereby reducing the amount of loss by $500 due to the profit made on the put option. The chart below shows at what price points the investor would exercise the options or let them expire.

Long strangle options are attractive to investors who are anticipating an instability in the market or on their currency. Times of uncertainty and unexpected news can be a good time to take on a long strangle option strategy.

OptionMarket RateMarket RateMarket RateMarket RateMarket Rate

Call

1.4200

1.4225

1.4250

1.4275

1.4280

Profit/Loss (Put Expires/Call Exercised))

$1500 loss

$1000 loss

$500 loss

Break Even

$40 profit

Put

1.4225

1.4200

1.4175

1.4150

1.4145

Profit/Loss (Call Expires/Put Exercised)

$1500 loss

$1000 loss

$500 loss

Break Even

$40 profit

Straddle Strategy

The option straddle strategy is similar to a Strangle strategy except that the long call and long put are, unlike the Strangle, at exactly the same strike price and as with the Strangle, the same expiry date. Straddles are a good strategy to pursue if an investor believes that currency prices will move considerably but is unsure as to which direction. The currency price must move appreciably if the investor is to make a profit. A small price movement in either direction will cause the investor to take a loss. Consequently, a straddle is an extremely risky strategy to perform.

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

© 2011 Philip Cooper

Comments

Philip Cooper (author) from Olney on March 18, 2012:

Thanks for dropping by.

wlionpage from Ahmedabad, Gujarat, India on September 20, 2011:

I really appreciate your efforts, Thanks I am on Amplify:- http://dishapatel.amplify.com/

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