In order to increase the chances of success in any financial market, an investor must spend time and patience to educate himself and learn more about the market. An essential step in this process is developing your own trading strategy that can help you fulfill your investment goals. In the world of options trading, this means first learning about essential strategies such as the strangle option strategy and then employing it into your investment.
So, what is the strangle strategy and how can it help your option investments in the long run? Here is an overview of the strangle strategy, its types and how it is used by traders to maximise their investments.
What are Options?
Before we delve into the question of ‘what is a strangle’, let us first review the concept of options to better understand the context of strangle options. Options are a type of financial instruments known as ‘derivatives’ as their values are essentially derived from an underlying security. In terms of financial investment, an option is best defined as a form of contract that provides the buyer the right, but not the obligation, to sell or buy a given amount of an underlying asset at a predetermined price. This purchase or sale of the asset can take place only before the expiry of the options contract.
In order to understand the strangle option strategy, it is important to note here that this predetermined price in an options contract is known as the ‘strike price’. Moreover, an option that allows the investor to buy an asset is known as a ‘call option’ while the option that allows the selling of an asset is known as a ‘put option’.
How Strangle Strategy Works in Options Trading
Now that we have reviewed these essential concepts related to options, let us take a look at how they play into the strangle strategy. The strangle option strategy is employed by an investor when he holds a position in both a call option and a put option of the same underlying asset and with the same expiration date. However, these options are held at different strike prices.
As an investor, this allows you to benefit from the price movements of the underlying asset, no matter the direction in which the movement takes place. This strategy is beneficial if an options investor feels certain about the possibility of a sharp swing in an asset’s price but is uncertain about the direction.
Types of Strangle Strategy
As mentioned above, the strangle strategy is used by an investor to maximise his profits with an appropriate options investment. However, the exact form of strangle strategy used by an investor can vary across multiple strangle examples. Here are the two most commonly used strangle strategy examples as employed by options investors:
1. Long Strangle: One strangle option example is when the investor ‘goes long’ or buys both a call option and a put option of the same underlying security at different strike prices. The investor will make a profit in the event that the underlying price of the asset makes enough movement either above or below its current price. This means limited risk and in the event the investor is correct, result in unlimited profit potential.
2. Short Strangle: In this more neutral strangle option strategy, the investor sells both the call and put options on the same underlying security, simultaneously. The strike price for the call must be above the current price while being lower than the current price for the put option. Short strangle strategies are typically associated with limited profit and unlimited risk. This type of strangle strategyis ideal for an investor who expects the underlying asset to experience very little volatility.
As an investor in any financial market, it is essential to be aware of leading trading strategies such as the strangle strategy. In particular, if you are looking to invest in derivatives such as options, the strangle option strategy can prove beneficial when applied at the right opportunity. More often than not, strangle strategies require a substantial movement in asset prices in order to benefit the investor and also carry higher risk than strategies such as the straddle strategy.