The Strangle option strategy is a relatively low risk way to profit from an extremely bullish OR bearish outlook.

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Strategy: Strangle Purchase

The Outlook: Extremely Bullish OR extremely Bearish. Usually expecting a stock to either continue an up or down move OR reverse. Or expecting a dramatic move in the stock, but with the direction unknown, such as when positioning before an earnings report.

The Trade: Buy equal numbers of call(s) and put(s) using a strike price higher than the current stock price for the calls, and lower than the current strike price for the puts.

Gains when: Stock moves lower, past the lower breakeven, or stock moves higher, past the upper breakeven.

Maximum Gain: unlimited to the upside, limited by the stock falling to zero to the downside.

Loses when: Stock does not move beyond one of the breakeven points.

Maximum Loss : Limited to the initial debit.

Breakeven Calculation: Lower breakeven = put strike price - half of total debit. Upper breakeven = call strike price + half of total debit.

Advantages compared to stock: Increased leverage, much less capital required, "built-in" stop loss, don't need to pick a direction of movement.

Disadvantages compared to stock: Greater risk of 100% loss of the capital invested, more stock movement needed to gain.

Volatility: after entry, increasing implied volatility is positive.

Time: after entry, the passage of time is negative.

Margin Requirement : None. Initial debit must be paid in full.

Variations: Buy puts at the higher strike and buy calls at the lower strike. Both options will start off ITM instead of OTM, there is a much higher initial debit, but the position is otherwise the same.

Comments

• A Strangle Purchase is the same as buying OTM calls and OTM puts, so not only do you need to be extremely bullish or bearish, but the position needs to overcome the side that loses as well.

• A Strangle Purchase is a trade for speculators. There is a very good chance of a small loss, and a very small chance of a good gain.

• Most other features of a Strangle Purchase, including volatility effects, profit taking strategies, exits, and adjustments are similar to a Straddle Purchase, so you might want to read that page.