Strangle options are an options strategy where the investor buys and sells two different options contracts on the same primary security but with different strike prices and expiration dates. This strategy aims to profit from big moves in the underlying security, whether it is up or down.
Options traders use this strategy to take advantage of volatility in the markets. When volatility is high, the premiums for both the call and put options will be higher, resulting in a higher profit potential when the options are eventually sold.
There are two main times when strangle options can be profitable: when the underlying security is expected to make a big move and when implied volatility is high.
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When the underlying security is expected to make a big move
If you believe that the underlying security will make a big move, then strangle options are a great strategy to use. The reason is that you can profit whether the stock moves up or down, as long as it moves by a large enough amount.
For example, let’s say that you think Facebook will make a big move, and you want to take advantage of that move using strangle options. You could buy a call option with a strike price of £170 and sell a put option with a strike price of £160. It would give you a long strangle position.
If Facebook ends up moving above £170, your call option will be in the money, and you will profit. If Facebook moves below £160, your put option will be in the money, and you will profit. And if Facebook stays within the £160 to £170 range, both options will expire worthless, resulting in a loss.
When implied volatility is high
The expected future volatility of a security is implied volatility. It is calculated by taking the current price of an option and dividing it by the theoretical value.
When it is high, traders expect the stock to move by a significant amount in the future, which presents an opportunity for investors to use strangle options.
For example, let’s say that you think that GE will make a big move, but you’re not sure which direction the stock will move. You could buy a call option with a strike price of £27 and sell a put option with £25. It would give you a long strangle position.
If GE ends up moving above £27, your call option will be in the money, and you will profit. If GE moves below £25, your put option will be in the money, and you will profit. And if GE stays within the £25 to £27 range, both options will expire worthless, resulting in a loss.
When volatility is low
While strangle options can be profitable when implied volatility is high, they can also be profitable when volatility is low. Due to low volatility, the premiums for both the call and put options will be lower, resulting in a higher profit potential when the options are eventually sold.
For example, let’s say that you think that IBM will make a big move, but you’re not sure which direction the stock will move. You could buy a call option with a strike price of £180 and sell a put option with £170. It would give you a long strangle position.
If IBM ends up moving above £180, your call option will be in the money, and you will profit. If IBM moves below £170, your put option will be in the money, and you will profit. And if IBM stays within the £170 to £180 range, both options will expire worthless, resulting in a loss.
While strangle options can be profitable in all market conditions, they are most profitable when implied volatility is high. It is because implied volatility represents the expected future volatility of the stock. When it is high, there is a higher chance that the stock will move significantly. As a result, the premiums for both the call and put options will be higher, resulting in a higher profit potential when the options are eventually sold. Have a look at the Saxo capital markets here.