Straddle vs. Strangle: Options Strategies for Volatility

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Straddle vs. Strangle: Options Strategies for Volatility – Straddle vs. Strangle, Options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price and time. Options traders can use various strategies to profit from different market scenarios, such as volatility, direction, and time decay. Two of the most popular options strategies for volatility are straddles and strangles.

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Straddle vs. Strangle: What Is a Straddle?

A straddle is an options strategy that involves buying a call option and a put option on the same underlying asset with the same strike price and expiration date. A call option gives the buyer the right to buy the asset, while a put option gives the buyer the right to sell the asset.

A straddle is a neutral strategy that profits from large price movements in either direction. The trader does not have to predict whether the asset will go up or down, only that it will move significantly. The maximum loss of a straddle is limited to the amount paid for the options premiums, while the maximum profit is unlimited.

For example, suppose a stock is trading at $50 and a trader expects it to move sharply after an earnings report. The trader could buy a $50 call option and a $50 put option that expires in one month for $3 each. The total cost of the straddle is $6 per share or $600 for one contract of 100 shares.

If the stock moves above $56 or below $44 by expiration, the trader can make a profit by exercising the profitable option and letting the other one expire worthless. For instance, if the stock jumps to $60, the call option will be worth $10, while the put option will be worthless. The trader can sell the call option for $10 and make a profit of $4 per share ($10 – $6), or $400 for one contract. Conversely, if the stock drops to $40, the put option will be worth $10, while the call option will be worthless. The trader can sell the put option for $10 and make the same profit of $4 per share.

If the stock stays close to $50 by expiration, both options will lose value due to time decay and implied volatility drop. The trader will lose money if the stock ends up between $44 and $56 by expiration. For example, if the stock stays at $50, both options will expire worthless and the trader will lose the entire $600 paid for the straddle.

Straddle vs. Strangle: What Is a Strangle?

A strangle is an options strategy that involves buying a call option and a put option on the same underlying asset with different strike prices but the same expiration date. The call option has a higher strike price than the current price of the asset, while the put option has a lower strike price than the current price of the asset.

A strangle is also a neutral strategy that profits from large price movements in either direction. However, unlike a straddle, a strangle requires more price movement to become profitable, as both options are out of the money at inception. The advantage of a strangle is that it costs less than a straddle, as out-of-the-money options have lower premiums than at-the-money options.

For example, suppose a stock is trading at $50 and a trader expects it to move sharply after an earnings report. The trader could buy a $55 call option and a $45 put option that expires in one month for $1 each. The total cost of the strangle is $2 per share or $200 for one contract of 100 shares.

If the stock moves above $57 or below $43 by expiration, the trader can make a profit by exercising the profitable option and letting the other one expire worthless. For instance, if the stock jumps to $60, the call option will be worth $5, while the put option will be worthless. The trader can sell the call option for $5 and make a profit of $3 per share ($5 – $2), or $300 for one contract. Conversely, if the stock drops to $40, the put option will be worth $5, while the call option will be worthless. The trader can sell the put option for $5 and make the same profit of $3 per share.

However, if the stock stays close to $50 by expiration, both options will lose value due to time decay and implied volatility drop. The trader will lose money if the stock ends up between $43 and $57 by expiration. For example, if the stock stays at $50, both options will expire worthless and the trader will lose the entire $200 paid for the strangle.

Straddle vs. Strangle: Which Is Better?

There is no definitive answer to which strategy is better, as it depends on the trader’s outlook, risk tolerance, and budget. Here are some factors to consider when choosing between a straddle and a strangle:

Cost

A strangle is cheaper than a straddle, as it uses out-of-the-money options. However, this also means that a strangle has a lower probability of profit than a straddle, as it requires more price movement to break even.

Breakeven

A straddle has a lower breakeven point than a strangle, as it uses at-the-money options. However, this also means that a straddle has a higher maximum loss than a strangle, as it pays more for the options premiums.

Volatility

A straddle is more sensitive to changes in implied volatility than a strangle, as it uses at-the-money options. This means that a straddle can benefit more from an increase in implied volatility before expiration, but also suffer more from a decrease in implied volatility after expiration.

Direction

A strangle has some scope of directional bias than a straddle, as it uses out-of-the-money options. This means that a strangle can benefit more from a strong move in one direction than a moderate move in either direction, while a straddle can benefit equally from any significant move in either direction.

In conclusion, Straddles and strangles are options strategies that can help traders profit from volatility in the underlying asset’s price. Both strategies involve buying a call option and a put option with the same expiration date, but different strike prices. A straddle uses at-the-money options, while a strangle uses out-of-the-money options. A straddle costs more than a strangle but has a lower breakeven point and higher probability of profit. A strangle costs less than a straddle, but has a higher breakeven point and lower probability of profit. A straddle is more sensitive to changes in implied volatility than a strangle, while a strangle has some scope of directional bias than a straddle. Traders should consider their outlook, risk tolerance, and budget when choosing between these strategies.

Frequently Asked Questions on Straddle vs. Strangle (F&Qs)

Is straddle more profitable than strangle?

Straddles are generally more profitable than strangles if the security experiences a large price move. However, they are also more risky, because they require a larger price move to be profitable. Strangles are less risky than straddles, but they are also less profitable.

What is the difference between straddle and strangle options?

A straddle is a neutral options strategy that is used to profit from a large price move in either direction. To create a straddle, an investor buys a call and put option with the same strike price and expiration date. The investor will profit if the price of the underlying security moves significantly from the strike price, regardless of whether it moves up or down. While A strangle is also a neutral options strategy, it is less risky than a straddle. To create a strangle, an investor buys a call and put option with different strike prices and the same expiration date. The investor will profit if the price of the underlying security moves significantly from either strike price, but it will require a larger move than a straddle.

Why would you do a straddle?

There are several reasons why someone might choose to do a straddle.

  • To profit from a large price move in either direction
  • To hedge against the risk
  • To speculate on a large price move

What is the difference between being long a straddle and being long a strangle?

The main difference between a straddle and a strangle is the strike price of the options. In a straddle, the strike price of the call and put options is the same. In a strangle, the strike price of the call and put options are different.

Straddle vs. Strangle