Options Education Center

What is a strangle spread?

A long strangle is an options strategy that involves buying a call and a put option. Both options are out-of-the-money, on the same underlying security, and with the same expiration date. It is similar to a straddle except for the different strike prices.

This versatile approach can allow traders to potentially benefit from significant price changes without needing to predict the direction. As a debit spread, the strategy may also benefit from increased implied volatility.

The intention is to profit from a large price movement from the underlying security in either direction, with one of the options increasing in value above the initial cost to enter the strangle.

A short strangle, on the other hand, is a far riskier strategy that should only be attempted by experienced and well-funded traders. It involves selling an out‐of‐the‐money call and put on the same security and expiration.

Short strangles look to benefit from the underlying price remaining between the short strikes until the expiration of the options. Due to the extreme risk of the naked short options, traders may opt for an iron condor to limit the risk. For more on iron condors, see our article in the TradeStation Options Education Center.

Why use strangle spreads?

A trader may use a long strangle on a security with relatively low implied volatility that is expected to have a large price movement. Events such as earnings reports, court rulings, economic data releases, Federal Reserve announcements, product launches, or regulatory updates could trigger the move. The strangle is used to potentially profit from a large move in a stock’s price.

They can also be used to hedge from an index or ETF’s reaction to economic news. Other potential benefits of the strangle include limiting risk when there is uncertainty about the direction a market may move and offering potential profits from rising market volatility.

Risks of strangle spreads

How to create a long strangle

Long strangle risk/reward profile

Choosing the strike prices

The choice of strike price is important for the desired potential outcome of a strangle. Here are some considerations:

The narrow 250/260 strangle costs $53.10. The breakeven prices are 196.90 and 313.10.

The wider 240/270 strangle costs $44.12, but the breakeven points are farther at $195.88 and $314.12.

Your choice depends on your market outlook, expectation of price movement, and risk tolerance.

Time decay and strangle spreads

Time decay, or theta, negatively impacts long strangles:

How volatility affects strangle spreads

Strategy example – long strangle

Using RadarScreen^® in the Strangle workspace to filter for candidates, Smartsheet Inc. (SMAR) appeared in the Implied Volatility % change-down filtered list with earnings scheduled in 41 days.

The daily chart reveals that the stock typically gaps following earnings releases, and is experiencing lower-than-average volatility, which tends to rise as it approaches the announcement.

The January 17 options expire in 113 days, meaning there will be 72 days left after the earnings announcement. This extended timeframe means that the options will experience very little time decay. In contrast, if we chose the November options, the time decay would erode much of the premium as we approached the earnings date.

Loading the strangle into the analysis tab of OptionStation Pro lets us see the risk profile and potential theoretical outcomes. The yellow line represents the profile on the options expiration date.

By adjusting the plot to the day after the earnings release, we can identify the probable breakeven prices and maximum loss should the price fail to move past the strike prices. Remember, there will still be time value left.

On November 6, the breakeven prices are $54.94 and $57.89. If the earnings cause SMAR to move past either, we may be able to sell the strangle for a profit. Conversely, if the price fails to move beyond either strike, we could sell and incur a loss limited to the time value of approximately -$13.75 instead of the maximum potential loss of $35.

Monitoring and exiting a long strangle spread

Strangles are extremely sensitive to time and momentum, they need regular supervision and possible adjustments throughout the trade. The strangle can be held until expiration, although the time value would be lost. If one option is in-the-money at expiration, it will be automatically exercised, and the trader will be responsible for the new position in the underlying. Ensure your account is well funded, and you are prepared to handle an exercise or assignment.

Strangles are commonly sold to close for either a profit or a loss before expiration. If the underlying price moves to or beyond a certain level, traders can use the activation rule tool to set a stop-loss or take-profit order. Explore the article and video in the Options Education Center for more information on activation rules.

Additionally, the strangle can be closed after the expected event to recover the time value and the possible intrinsic value gained.

Practice with simulated trading

You can log in to Simulated Trading mode within TradeStation to practice placing, managing, and exiting strangles with various configurations without the risk of loss. As you become more familiar with these strategies, you can incorporate them into your live trading, starting with small positions.

Conclusion

Strangles can be an effective tool in an options trader’s arsenal, providing flexibility to hedge, and potentially profit from big market moves and increased volatility. However, like all trading strategies, they come with risks. It’s crucial to thoroughly understand how strangles work before using them with real money.

Remember, successful options trading requires ongoing education and practice. Start by paper trading strangles using tools like TradeStation’s Option Station. As you gain confidence, incorporate these strategies into your live trading plan.

By understanding this versatile approach, you’ll be better equipped to handle various market conditions and potentially enhance your trading results.