Papale on Strangles

Just dropped my son off to high school orientation.  Since I have a few gray hairs and some perspective on these types of life milestones, I figured I would share some of my wisdom with him.  After a few minutes of my “Father Knows Best” stuff, I got the “Ok Dad, thanks but things are different now”.  Wow.  I have become my dad and my son has become me.

Last week we discussed how and when we might use a straddle in our trading.  For the trader who is expecting a move but not sure of which way, it is a high octane strategy of choice.  However it is not the only choice.  Another strategy that can perform in a high volatility environment is the long strangle.  A long strangle, like a straddle is long a call and a long put.  The difference is in the strangle the calls and puts are both out of the money.  By going out of the money the cost of putting the strangle on is lower.  However, since the strikes are further out, it takes longer for the payoff to occur.

For example, if XYZ is trading at $100, we might buy the 110 call/90 put strangle for $2.  For the strangle to be profitable, we would need the stock to rise above $112 or fall below $88 – the strike prices plus or minus the cost of strangle.  The further out of the money the options are, the greater the move needed to become profitable.  Nonetheless, the strangle has less greek risk than the straddle and is sometimes referred to a “poor man’s straddle”.  But this poor man’s straddle can lead to some nice profits with less risk under the right market conditions.

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