Strangle

Quick Summary of Strangle

A strangle strategy is selling both an out-of-the-money call and an out-of-the-money put.

This works best when the underlying stock moves very little, and neither option is exercised. It covers you if one side moves more than the other side of the spread. It’s a form of straddle. It’s called a short straddle. You’re selling both call and put in the same stock, at the same exercise price, with the same expiration date.

A strangle is an advanced options strategy that requires the investor to be long both an out-of-the-money call and an out-of-the-money put. To properly execute the strangle, the investor must buy a call and put with same expiration date, but with different strike prices. A strangle tends to be used by an investor that thinks a stock will move significantly but is unsure as to which direction. For example, if a drug company is set to disclose whether the FDA approved or disapproved their new miracle drug, an investor may employ a strangle in anticipation of the stock price trading sharply higher on approval or plunging lower on disapproval.

For example, an investor who wants to trade a strangle on ABC Inc. when that stock is trading at $45 in May might opt to buy a June 50 call and a June 40 put. To set up this strangle, the trader may purchase the call for $5 ($5 x 100 shares=$500) and the puts for $2 ($2 x 100 shares=$200). That brings the cost of the strangle to $700. For the strangle to become profitable, ABC must move significantly out of the $40-$50 range. For example, if ABC moved to $60, the $50 calls would be worth $10 and the trader could sell his contracts for $1,000, covering the $700 cost of the strangle and netting a $300 profit. On the downside, ABC would need to drop to at least $33 for the strangle to break-even. The above example does not take into account the commissions required to execute the strangle.

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