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Visually Analyze Option Strategies
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Strangle

 

Description

 

The Strangle is a simple adjustment to the Straddle to make it a little cheaper.

 

Instead of buying at-the-money options, you buy out-of-the-money calls and puts, which creates a lower cost basis and therefore potentially higher returns. The risk you run with a Strangle is that the break evens can be pushed further apart, which is bad, but where the difference is not too great then the Strangle can be fantastic.

 

You simply buy lower strike puts and higher strike calls with the same expiration date so that you can profit from the stock soaring up or dropping down. As with the Straddle, each leg of the trade has limited downside (i.e., the call or put premium) but uncapped upside.

 

Again, the same challenges apply regarding Bid/Ask Spreads and the psychology of the actual trade. Remember that time decay hurts long options positions because options are like wasting assets. The closer you get to expiration, the less time value there is in the option. Time decay accelerates exponentially during the last month before expiration, so you do not want to hold onto options into the last month.

 

Market Opinion

 

Direction neutral.

 

P/L

 

 

 

 

 

 

 

 

 

When To Use

 

Use this capital gain strategy when you anticipate greatly increasing volatility in the price of the stock, in either direction.

 

Example

 

XXXX is trading at $25.37 on May 14, 2011.

Buy August 2011 $22.50 strike put for $0.85.

Buy August 2011 $27.50 strike call for $1.40

 

Net debit: premiums bought = $2.25

 

Benefit

 

The benefit is the possibility of unlimited profit from a volatile stock moving in either direction, with capped risk, and less expensive than doing a Straddle.

 

Risk vs. Reward

 

The risk is limited to the net debit of the puts and calls you bought. The reward is unlimited.

 

Net Upside

 

Unlimited.

 

Net Downside

 

Net debit paid.

 

Break Even Point

 

Break even up: higher strike plus net debit

 

Break even down: lower strike minus net debit

 

Effect Of Volatility

 

Positive, especially between the strike prices.

 

Effect Of Time Decay

 

Negative. Time decay also accelerates the fastest in the last month.

 

Alternatives Before Expiration

 

Try not to hold in the last month as time decay accelerates then.

 

If the stock drops significantly, sell the put to make a profit and wait for retracement to profit from your call.

 

If the stock rises significantly, sell the call to make a profit and wait for a retracement to profit from the put.

 

Always close the trade out after a news event occurs when there is no movement in the stock.

 

Alternatives After Expiration

 

Close out the position by selling your puts and calls.

 
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