Finance:Strangle (options)
In finance, a strangle is an options strategy involving the purchase or sale of two options, allowing the holder to profit based on how much the price of the underlying security moves, with a neutral exposure to the direction of price movement. A strangle consists of one call and one put with the same expiry and underlying but different strike prices. Typically the call has a higher strike price than the put. If the put has a higher strike price instead, the position is sometimes called a guts.[1]
If the options are purchased, the position is known as a long strangle, while if the options are sold, it is known as a short strangle. A strangle is similar to a straddle position; the difference is that in a straddle, the two options have the same strike price. Given the same underlying security, strangle positions can be constructed with lower cost and lower probability of profit than straddles.
Characteristics
A strangle[note 1], requires the investor to simultaneously buy or sell both a call and a put option on the same underlying security. The strike price for the call and put contracts are usually, respectively, above and below the current price of the underlying.[2][3][4]
Long strangles
The owner of a long strangle makes a profit if the underlying price moves far away from the current price, either above or below. Thus, an investor may take a long strangle position if they think the underlying security is highly volatile, but does not know which direction it is going to move. This position is a limited risk, since the most a purchaser may lose is the cost of both options. At the same time, there is unlimited profit potential.
Short strangles
Short strangles have unlimited losses, and limited potential gains; however, they have a high probability of being profitable. The assumption of the short seller is neutral, in that the seller would hope that the trade would expire worthless in-between the two contracts, thereby receiving their maximum profit.[3][4] Short strangles are known to exhibit asymmetrical risk profiles, with larger possible maximum losses being observed compared than the maximum gains to the upside.[5]
Active management may be required if a short strangle has become unprofitable. If a strangle trade has gone wrong and has become biased in one direction, a seller might add additional puts or calls against the position, in order to restore their original neutral exposure.[3] Another strategy to manage strangles could be to roll or close the position before expiration; as an example, strangles managed at 21 days-to-expiration are known to exhibit less negative tail risk[note 2], and a lower standard deviation of returns.[note 3][6]
Notes
See also
References
- ↑ Natenberg, Sheldon (2015). "Chapter 11". Option volatility and pricing: advanced trading strategies and techniques (Second ed.). New York. ISBN 9780071818780.
- ↑ 2.0 2.1 Hull, John C. (2006). Options, futures, and other derivatives (6th ed.). Upper Saddle River, N.J.: Pearson/Prentice Hall. pp. 234–236. ISBN 0131499084.
- ↑ 3.0 3.1 3.2 McMillan, Lawrence (2002). Options as a strategic investment (4th ed.). New York Institute of Finance. pp. 315–320. ISBN 9780735201972.
- ↑ 4.0 4.1 Natenberg, Sheldon (22 August 1994). Option Volatility and Pricing: Advanced Trading Strategies and Techniques. McGraw-Hill. pp. 315–320. ISBN 9780071508018.
- ↑ Kownatzki, Clemens; Putnam, Bluford; Yu, Arthur (27 July 2021). "Case study of event risk management with options strangles and straddles". Review of Financial Economics. ISSN 1058-3300. http://explore.bl.uk/primo_library/libweb/action/display.do?tabs=detailsTab&gathStatTab=true&ct=display&fn=search&doc=ETOCvdc_100146761097.0x000001&indx=1&recIds=ETOCvdc_100146761097.0x000001.
- ↑ Spina, Julia (2022). The Unlucky Investor's Guide to Options Trading. Wiley. ISBN 9781119882657.
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