A Long strangle is a strategy having multiple legs. In this strategy, the risk is predefined and limited, while the profit potential is unlimited. In this strategy, the trader buys a long call and long put option at out-of-the-money having the same expiry date. The objective of this strategy is to benefit from the high market volatility. Traders have the potential to earn profit regardless of the direction of the price movement. As a trader has a long call and long put, he can profit from both directions.
Long strangles from the market perspective:
Long strangle strategy is a market-neutral strategy that does not create any bias based on the direction of the price movement. In Long strangles, the price movement must be significantly high to exceed the breakeven point in both directions. It must face high price changes or high volatility to make an unlimited profit.
With the significant implied volatility, the price of the stock also rises. The advantage to the investor in a long strangle is to get the benefit from the price movement of the underlying stock in any direction. The premium collected is also very high during the exit due to high volatility.
A long straddle and a long strangle objective are the same to get unlimited profit from either direction. Both strategies take advantage of the large price movements and high volatility. The cost of entering long strangles is comparatively low because the strike price is out-of-the-money. Both of them require a significant enough move in the stock price or high volatility to see a considerable profit as the prices are very far away from the current price.
Learn to set up a long strangle
You can set up the long strangle by buying the long call and long put options contract together having the same expiry date. The cost of buying both the options contract will be the highest loss in this trade.
As seen earlier, this strategy profits from the high price rise and great implied volatility, the potential to make a profit after deducting the premium amount paid is unlimited.
The Diagram of Long strangle:
If you are aware of the diagram, it becomes very easy to identify and take necessary actions on the trade visually. So, any options trader must know the basic structure of the strategies to get a brief idea.
The long strangle is represented by the "English alphabet letter - U". Any trader's max loss is limited to the cost paid for buying the long call and long put options contracts initially. There are limitless profit-making opportunities if the price undergoes a large move in either direction before the contract expires.
The net profit would be the amount received at the time of exit - the premium paid while entering into the strategy.
For example: suppose the stock is trading at Rs. 100 per share, then a trader can enter into a long strangle by buying an Rs. 95 Put and Rs. 105 call option. Suppose both the contracts are bought by paying Rs. 5 as the premium; then the price must go beyond 110 (105+5) or below Rs. 90 at the expiry time to get the maximum profit.
How can I enter into the long strangle strategy?
The long strangle is nothing but the long call option and long put option purchased together having the same expiry date. The options are purchased far away from the strike price in both directions.
If we continue the above example, assume that the stock's current price is Rs. 100, then the long call option can be purchased at Rs. 105, and similarly, the long put option can be purchased with the strike price of Rs. 95.
The farther the strike price of the purchased options, the less they will cost, but they will require a significant move to make money. If the underlying asset price is high or has more demand in the market, its cost will also be accordingly high. If there is high volatility in that stock, it will also increase the cost of the options premium. Furthermore, the more time the contract has to expire, the more costly it will be.
Buy-To-open at Rs. 95 Put options contract
Buy-to-open at Rs. 105 Call options contract
How can I exit from the long strangle?
As we have seen previously, the long strangles can benefit if there is high implied volatility, a high rise in the price or both before the contract expiry date. In order to exit from the trade, traders must sell two long options contracts. The price difference between at which the options contract was bought and was sold is the net profit or net loss on this trade.
Generally, the trader's exit the long strangles before expiring to gain the advantage of the remaining intrinsic value. This way, the trader can exit from the strategy and make some money.
Impact of time decay on the long strangle:
Just like a long straddle, in a long strangle also, the time decay or theta works against this strategy. With each passing day, the value of the underlying stock decreases. The large moves happen for a very short time, and traders need to keep an eye on the fluctuations and act fast by selling the options.
The impact of Implied volatility on the long strangle:
The implied volatility factor can be considered the long strangle friend. Because with the rise in the implied volatility, options premium price also rises. In the general scenario, the volatility is low at the beginning and gradually increases as the time to expire approaches. Though it is difficult to predict the future volatility or vega factor, it may help a trader if he knows its impact on his existing position.
How can I adjust the long strangle?
Long strangles have a reasonable amount of time to make a profit; also, many factors are working against its success. Imagine a situation where the underlying asset's price does not change significantly, or if the volatility decreases, the long strangle will result in a loss.
Just like every other strategy, this strategy can also be adjusted. But it may incur the additional cost, a debit and will also increase the breakeven points for that trade.
Long strangles can be adjusted and turned into the reverse iron condor strategy by selling the options contract above the call and below the put. The amount gained by selling them limits the max loss, and the profit is limited to the spread width after deducting the total amount paid.
For example: if there is no significant move in a long strangle, then a put of the strike price of Rs. 95 and a call of a strike price of Rs. 105 can be converted into an Iron condor. To do so, a trader needs to sell puts at Rs. 90 and call at Rs.110. By assuming that additional Rs. 1 credit is received, the maximum loss will be reduced by Rs. 100, and the profit potential will not remain unlimited.
Sell to open - Rs. 90 put options (below the Rs. 95 strike price)
Sell to open - Rs. 110 call option (above 105 strike price)
How to Roll a Long strangle?
The traders can roll the long strangle to some future date if the conditions are not favourable. To do so, they need to sell to close (STC) their current position and enter into new positions by buying Buy to open (BTO) positions. Traders may keep the strike price the same as before or make any changes based on the market price.
The disadvantage of rolling this strategy is an additional cost that a trader has to bear. It will increase the amount of potential loss, and more price rises will be needed to meet the breakeven point.
How to hedge a long strangle?
Hedging can be considered a proactive approach towards retaining the profit if there is a sharp price movement before the expiry. It will minimize the overall risk. A sustained move in any one direction can make a profit in this strategy. Sometimes, the stock moves quickly and returns immediately, leaving no chance to profit.
If the underlying asset shows an upward movement, then the trader or investor may select to hedge in the opposite direction, that is, downwards via put options. Similarly, the stock can be hedged via call options if it shows a downward movement.
For example, A wide Rs. 10 long strangle is bought on the Rs. 100 stock by paying an Rs. 5 premium, and the stock faces a sharp rise of Rs. 105, which is above the long call. In this scenario, one method to hedge this position is by ordering sell-to-close (STC), the put at Rs. 95, and buy-to-open another put at a higher price. This action may lead to narrowing the spread width as the strangles are purchased out-of-the-money. Heading the stranglers using this method can prove to be very expensive and will also require a large move to profit. This technique will help define the risk and will not limit the upside profit potential of the position.
We hope you are all clear with the long strangles. If you need to understand more deeply or have any questions related to the long strangles, please get in touch with our expert team to resolve your query instantly.