What is a strangle in options trading?
(Last Updated On: 1. July 2022)
A strangle is one of the very common strategies in options, and every beginner in options trading will learn to know this one (amongst some of the other basic strategies). In this article we are going to answer the question “What is a strangle in options”. Also, we will check the differences between a long and a short strangle, and check which of both strategies is better. So, let’s start!
What is a strangle in options
So what is a strangle? It’s a common and popular strategy (check the chart below) in which a trader opens two positions on the same asset – one on the call side and the second one one the put side. Although the strike prices are different, the expiration date is, however, the same. In our example the call has a strike of around $21.50 and the put of around $12.
There are two ideas how to make money with a strangle, depending on whether the option traders open a long strangle position or a short strangle position. Therefore, let’s check them both and we will begin with the long strangle.
What is a long strangle
In a long strangle, the trader is buying two options – a call option and a put option. The strike of the call option is higher than the current market price of the security, while the put is respectively lower than the price of the security. It’s that simple, folks.
The idea behind this method is that theoretically, the price of the security can rise unlimitedly and this would also drive up the profit of the option without any limits. On the underside, a price of a security can always fall to zero (we saw an exception on Crude Oil with a negative price). But the profit here could be also enormous.
Pros and cons of a long strangle
- The profit can be huge to “unlimited”
- The risk is fixedly calculated because you can only lose what you’ve spent to buy the both strangle options
- The probability that you would achieve “unlimited” profit with a strangle option is very theoretical and very unlikely
- Even for “normal” profits you need the asset to make big changes in its price which is not predictable, even during the earnings season
- The strategy of a long strangle is rather usable with a pretty low implied volatility. In times of a high implied volatility the chances that you wouldn’t earn any money even if the price of the security would make big movements are omnipresent. Therefore, as from my point of several years of experience, a method of a long strangle option is better suitable for trading options on futures than on stocks or ETFs
What is a short strangle
In a short strangle, option traders do just the opposite of a long strangle: instead of buying two options they sell a call option and a put option. The strike of the short call option is also higher than the current market price of the security, while the put is lower than the price of the security.
The idea behind this method is the argument that it is easier to say where the price of the security will NOT go instead to make an exact prediction (like in case of a long strangle). In other words, statistically, it’s easier to earn money with sold options because you just sit and wait as long as the price of the security is moving sideways and doesn’t touch one of the strike prices. At least, it’s what the statistic is showing us. But there is, of course, the other side of the coin. By selling options (it doesn’t matter whether a strangle or a different strategy), you will always have a limited profit, but the loss can be unlimited if you don’t take care of your positions and don’t take precautions to limit your losses.
Pros and cons of a short strangle
- The probability that you would gain profits with a short strangle is significantly higher than with a long strangle. To achieve profits, it’s enough to wait and watch the price of the security moving sideways while the worth of the option is decreasing a bit every day towards the expiration date.
- This strategy is suitable in phases of high implied volatility
- The profit of a short strangle is always limited
- The risk on the call side can be unlimited unless you take precautions. If you want to know more about option trading strategies and the precautions, check this online course*, folks
- The strategy of a short strangle is usable rather with a pretty high implied volatility. As from my point of several years of experience, a method of a long strangle option is suitable for trading with options on futures but also on stocks during the earnings season
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Trading long or short strangle – what is better?
Now, as you know the answer for the question of what is a strangle option, it’s time to answer the next question which is whether to use the long or the short strangle method.
There is actually no correct answer possible because it all depends on you, your preferences and your trading skills. In my case, what did my experience tell me? Well, as I traded options on futures and options on stocks as well, I had the impression that trading short strangles on futures was more profitable and less stressful according to volatility.
In general, trading strangle options on futures is more profitable because when you trade options on futures, you will get on the call side the same premium than on the put side. Sometimes even more premium! When you trade short strangles on stocks, you will get on the call side always less premium due to the so-called skew.
Why was it less stressful? Because the volatility (not the implied volatility!) on futures is usually lower than in case of stocks and ETFs. Of course, there are always exceptions in extreme situations in futures, too. But a price of crude oil will usually never jump from $20 to $100 over night. In the world of stocks, it’s indeed very possible.
Also, trading short strangles is dependable on high implied volatility. The higher the implied volatility, the higher would be the premium. And as an option seller, you always look for high implied volatility to get as much premium as possible. After all, as an option seller, you’re want to be rewarded for the risk you’re taking, right?
Hence, to sum it up: from my point of experience, trading short strangles is better suitable at options on futures because of the higher premium, less volatility, and because of no skew in the world of futures.
In the world of stocks, it’s better NOT to use the short strangle method at all. Selling strangle options on stocks and other securities has too many disadvantages on the call side: you always get a lower premium on the call side, and the volatility in the world of stocks can ruin your account over night. Therefore, using another method, called iron condor, is more suitable in the world of stocks. But that’s another story and you can check this online course* if you want to learn how to trade options in a serious way.
What about long strangles? Well, this method would require you to predict a movement. Therefore, you need to be a real good directional trader or at least, a very good guesser. Another possibility is to bet on the high implied volatility. There are moments you can “predict” this in the world of futures but also on stocks. Especially on stocks, because every option trader knows that during the earnings season, the implied volatility reaches pretty high levels. So when you catch a moment of a low implied volatility and set up a long strangle, you can earn money with this method when you close your position when the implied volatility reaches the highest level which is on the day before the publication of earnings of a stock.
But nevertheless, from my point of experience, it’s harder to earn money with long strangle options, and you need to be a better options trader than a short options trader.
Final words about trading options
Trading options is no rocket science, and everyone can set up strangles or apply other option strategies. And everyone can make money by trading options by delving into this seriously, e.g. by reading some books about options trading or enrolling a paid online course or a free one, and so one.
The actual challenge is the trader’s mentality! It’s the greed that needs to be bridled and the acceptance of the fact that not every trade will be a perfect one. You can check some of the trades I’m publishing from time to time. All of those trades I set up in my real money trading account, and if you check them, you will find several trades which didn’t work out as expected.
In other words, speaking about trader’s mentality: it’s not easy to run a proper risk management to reduce losses and not to exaggerate so it would be possible to generate profits in a long term. If you’re a beginner and looking for a good trading book about risk management, I can recommend you the book “Trading Risk by Kenneth L. Grant“*. Another good book about trading psychology is the one called “Mastering Trading Psychology“* by Andrew Aziz.
But at the end it’s not the theory but the experience and the mental training which matters. So as a beginner, you need to expect losses, and in your first year as an option trader your goal should be not to make huge profits but to make sure your trading account is still not broken. Then, when you made this first hurdle, you can start to approach to your first surplus year. In total, to become a profitable options trader in a long-term perspective, it takes between 3 and 5 years of your lifetime.
With this in mind, take care of your money and happy trading!
*Affiliate link: when you click on this link, no additional costs would arise for you and the product or the service will not become more expensive. When you decide to buy the product or use the service, I’ll get a little benefit from the provider which I would reinvest to keep this blog alive.