Long Strangle Trading Strategy

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• in Derivatives
• on March 15, 2012
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Long Strangle trading strategy consists of one call and one put option positions at the same time. Here the trader buys one put option at the lower strike price (XL) and buys one call option at a higher strike price (XH). Call option premium C will be same as put option premium P.

XL = USD 100; XH = USD 120 C = USD 10; P = USD 10

Current Share Price, S0 = USD 80

Total Premium Paid = USD (10 + 10) = USD 20

Maximum Loss happens when both the options are expired and this happens between the stock price range of USD 100 and USD 120. The maximum loss will be equal to the total premium paid which is USD 20.

Maximum Profit will be unlimited as the market moves in any direction. Either the Put or the call option will be in the money if the market moves in any direction. The profit payout can be easily understood from the below payout diagram.

Breakeven price is the share price where the profit stood at 0 and it separates profit from loss. There will be two breakeven prices here, one is USD 140 and another is 80 USD. At these prices, the loss from total premium paid will be recovered from any one option. The breakeven price can easily be determined from the table and the chart.

The following table shows the profit/loss scenarios for different share prices.

Long Strangle

The below chart shows the profit/loss for the trading strategy option with the movement of the share price.

Long Strangle Chart

Here we have three graphs

1. Profit/Loss from Buying Call option at higher strike price XH (USD 120)
2. Profit/Loss from Buying Put option at lower strike price XL (USD 100)
3. Total Profit/Loss

Long Straddle trading strategy is used when the trader is bullish on volatility but is unsure of market direction. A long strangle is similar to a straddle except the strike prices are further apart, which lowers the premium of the spread but also widens the gap needed for the market to rise/fall beyond in order to be profitable.

Like long straddles, buying strangles is best you expect a large movement of market price in either direction.