Education Topics on Derivatives – Futures and Options (F & O)

Understanding of Strangle Options Trading Strategy

In earlier topic we have covered a strategy called Straddle & now we are going to cover a options strategy called as strangle. In this section you will be able to understand the strategy and when to use and how to use to make profits.

What is Strangle?

A strangle is an Options Trading Strategy which involves simultaneous buying or simultaneous selling of both a call option (CE) and a put option (PE) for the underlying asset with different strike price and the same expiration date.

Strangle is similar to the options strategy Straddle; however it involves different strike prices.

Long Strangle

A long strangle is an options strategy in which a trader simultaneously buys an out of the money (OTM) call (CE) and an out of the money (OTM) put (PE) option. The call option’s (CE) strike price is higher than the underlying asset’s current market price, while the put option (PE) has a strike price that is lower than the underlying asset’s market price.

Long Strangle Options Trading strategy has a large profit potential since the call option (CE) has theoretically unlimited upside, if the underlying asset rises in price, while the put option (PE) can profit if the underlying asset price falls.

The risk on the trade is limited to the premium paid for buying of call (CE) and put (PE) options.

So lets us understand the long strangle options strategy with live example of Nifty

Let us first have a look at Nifty Technical Chart

By looking at the above technical chart of Nifty you can say that Nifty is moving in the range & current close is at 16275 & if a trader is having a view that nifty can give a big move out of the marked range then a trader will form a strangle to make a use of range and he’s unsure about the direction of price move.

Nifty Spot Price: – 16275 (11.08.2021 close price)

So a trader can create a Strangle by selecting any of the strike prices, form the above charts instant strike prices selected are 16150 & 16350. 

i.e. Buying Nifty 16350 CE Expiry 26^th August 2021 at CMP 109.15 & Buying Nifty 16150 PE Expiry 26^th August 2021 at 95.90

So here net premium paid is

(109.15 X 50 = 5457.5)  + (95.90 X 50 = 4795) = 10152.50

Maximum Margin (Premium) required for this Trade is 10152.50

Breakeven for this 15945 -16555 on expiry day.

So a trader can only make profits on expiry day if it goes beyond 16555 or goes below 15945. Let us have look at the below payoff diagram for the strategy.

So theoretically this strategy gives unlimited profits, however if looked into practically the trader can only make profits if the underlying assets gives one way strong move. The chance of winning in this strategy is 50:50.

So one should have very clear understanding of the technical charts must understand the markets moves trending, range bound, breakout etc for getting the success by using this strategy.  

Short Strangle

A short strangle is an options strategy in which a trader simultaneously writes (sells) an out of the money (OTM) call (CE) and an out of the money (OTM) put (PE) option. The call option’s (CE) strike price is higher than the underlying asset’s current market price, while the put option (PE) has a strike price that is lower than the underlying asset’s market price.

Short Strangle is a neutral strategy with limited profit potential. A short strangle profits when the price of the underlying asset trades in a narrow range between the breakeven points. The maximum profit is equivalent to the net premium received for writing the call option (CE)  & put option (PE).

So lets us understand the short strangle options strategy with live example of Nifty by using the same technical chart of nifty which is used for illustration of long strangle strategy.

Nifty Spot Price: – 16275 (11.08.2021 close price)

So a trader can create a Short Strangle by selecting any of the strike prices, form the above charts instant strike prices selected are 16150 & 16350. 

So a trader can create a short strangle such as   

i.e. Selling (Call Writing) Nifty 16350 CE Expiry 26^th August 2021 at CMP 109.15 &  Selling (Put Writing) Nifty 16150 PE Expiry 26^th August 2021 at 95.90.

So here the trader can expect a maximum premium of  

(109.15 X 50 = 5457.5)  + (95.90 X 50 = 4795) = 10152.50

Maximum Margin required for this Trade is approx 110074.

Breakeven for this 15945 -16555 on expiry day.

So a trader can only make profits on expiry day if it remains range bound between 16555 & 15945. Let us have look at the below payoff diagram for the strategy.

Probability of making profits in this strategy are higher compared to the long strangle, however one should have a clear understanding of market directions.

So from the above example you must have understood the term strangles and the long strangle and short strangle concepts.

More over very interesting and key factor every trader must understand that the short strangles with adjustments gives much better results and regular income for traders. Most of the professional traders do follow the concept of the short strangle and in case markets gives unidirectional moves they do adjustments so that even if the markets moves one direction they makes money out from this strategy.

The strangles can also be used for intraday trading & with adjustments if required the strategy can give good results. This strategy can also be automated through algo trading so that the traders can make money through the same however the chances of winning depends on the market volatility and range.

Those who are interested in algo trading on the concept of straddle and strangle concepts can contact us for software related queries.

Disclaimer : – The Strategy is only for Educational Purpose and not a recommendations to follow.

Educational Videos on Stock Market