Strangle

A Strangle consists of a call option and a put option that have a different strike price and same expiration date. The only difference between straddle and strangle is – In straddle, we have the same strike price!

It is a neutral strategy that profits when the stock stays between the short strikes as time passes, as well as any decrease in implied volatility.

Directional Assumption: Neutral

Setup:

  • Sell/Buy OTM Call
  • Sell/Buy OTM Put

Ideal Implied Volatility Environment: High

Variations of Strangles:

strangle

If both options are purchased then it is called Long Strangle and vice versa.

Let’s consider The NIFTY spot price is at 9915.25. Now –

  • Sell 9800PE, Sell 10000CE
  • Sell 9800CE, Sell 10000PE

Both are strangles. But it sounds confusing. To remedy that, It is assumed that strangles are constructed with OTM options. The second variant which has both ITM options is known as Inverted Strangle or guts.

Also Note that the risk characteristics of a strangle (in terms of greeks) are almost similar to those of a straddle.

Although this is not enforceable, most traders chose their strike price in strangle so that the put delta and call delta are almost equal making the position delta neutral.

Also, price action traders don’t heed to delta but they choose the strike price based on technicals. Here is one such example –

nifty

The NIFTY spot price is at 9915.25 and here is our setup –

  • Sell NIFTY August 10200CE at 39.25
  • Sell NIFTY August 9600PE at 36.7

But one may ask now what is the reason for choosing a 300 points’ spread instead of just selling call options?

9900 + 300 = 10200 and 9900 – 300 = 9600.

Basically, when it is about the choice of next expiry I am looking at a higher timeframe of the daily chart. It is consolidating right now and although it looks like it is going to mean revert there is also a possibility of a breakout which we should not ignore!

Now, if the question comes to why the choice of 9600. And, Why not 9700 or 9500? That answer lies with Fibonacci as can be seen below. Although, again, discussion on technical analysis and price action is out of our current purview, it will be unsatisfying not to disclose the proper rationale.

nifty50

Max Profit: Net Credit received
= Total Premium Received
= Credit from short put + Credit from short call
= (36.7 + 39.25)
= 75.95

How to Calculate Breakeven(s):

  • Downside: Subtract initial credit from Put strike price.
  • Upside: Add the initial credit to the Call strike price.

So, in this case –

  • Initial credit =75.95
  • Downside: 9600 – 75.95 = 9524.05
  • Upside: 10200 + 75.95 = 10275.95

So we make money as long as it stays between 9524.05 and 10275.95. Like Straddle, IV plays a huge role in selection of strike prices in strangle too.

A higher IV means higher premiums i.e higher credits which ultimately means we will have wider breakeven points since we can use the credit to offset losses we may see to the upside or downside.

At the end of the day, a larger relative credit results in a higher probability of success with this strategy. But, the higher IV is a resultant of an event. As the outcome is uncertain, it becomes more risky too.

Like, IV gets insanely higher on results days’ of scrips or other fundamental events making it an amazing opportunity for strangle.

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