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Long Strangle

Overview

If you liked the Long Straddle but thought, "Gee, that's a bit pricey," then the Long Strangle might be right up your alley. Think of it as the Long Straddle's thriftier cousin – same volatility-loving DNA, but with a more budget-friendly approach.

With a Long Strangle, you're still buying both a call option AND a put option with the same expiration date, but here's the twist: you choose out-of-the-money options for both. The call strike is above the current stock price, and the put strike is below it. This creates a "strangle" around the current price – hence the somewhat alarming name. The good news? It's cheaper than a straddle. The catch? The stock needs to make an even bigger move to be profitable.

Key Characteristics

  • Market Outlook: "I'm betting on a massive move, but I'm too frugal for a straddle"
  • Risk: Limited to whatever you paid for both options (which is less than a straddle)
  • Profit Potential: Theoretically unlimited in either direction (minus what you paid)
  • Breakeven Points: Call strike plus your total cost (upper) and put strike minus your total cost (lower)

When to Use

The Long Strangle might be your strategy of choice when:

  • You're expecting a truly massive move from a stock (not just a little wiggle)
  • You want to play a volatile event but find straddles too expensive
  • You're willing to accept a wider profit zone in exchange for a lower entry cost
  • You've noticed a stock consolidating in a tight range before what looks like a major breakout
  • You want to make a volatility play but need to keep your risk capital in check

Real-World Example

Let's walk through this with a concrete example. Say XYZ stock is trading at $50, and they're about to announce earnings that you think will cause a major move.

  • You buy a $55 strike call option (that's $5 out-of-the-money) for $1.50 per share ($150 total)
  • You also buy a $45 strike put option (also $5 out-of-the-money) for $1.25 per share ($125 total)
  • Your total investment is just $2.75 per share ($275 total) – significantly cheaper than a comparable straddle
  • For this to be profitable, XYZ needs to move above $57.75 or below $42.25 by expiration

Now let's see what happens in different scenarios:

  • If XYZ rockets to $60 after blowout earnings, your call is worth $5 per share ($500 total), your put expires worthless, and you've made $225 profit ($500 - $275 cost)
  • If XYZ plummets to $40 after terrible earnings, your put is worth $5 per share ($500 total), your call expires worthless, and you've also made $225 profit
  • If XYZ moves to $53 – a decent move but not massive – both options will likely expire worthless, and you'll lose your $275 investment

The key difference from a straddle? You need a bigger move to profit, but you're risking less money. It's like placing a smaller bet on a longer-shot outcome.

The Good Stuff

  • Cheaper than a straddle – you're buying out-of-the-money options on both sides
  • Still gives you unlimited profit potential in either direction
  • Your risk is completely defined and limited to what you paid
  • You don't have to predict which way the stock will move, just that it will move big
  • If volatility increases after you buy, both options typically gain value

The Not-So-Good Stuff

  • Requires a much larger price move to be profitable compared to a straddle
  • Your breakeven points are further apart, making profitability less likely
  • Time decay still works against you every day the stock doesn't make its big move
  • If volatility decreases after you buy, both options lose value
  • If the stock price stays between your strike prices, you lose your entire investment

Playing It Smart

  • Choose your strike prices carefully – too far apart and you'll need an enormous move to profit
  • Consider using technical support and resistance levels to help select your strikes
  • Make sure your expiration date gives enough time for the big move you're expecting
  • Be realistic about the magnitude of move you're betting on – strangles need big swings
  • If one side becomes profitable after a big move, consider taking profits rather than hoping for more
  • Remember that the wider your strikes, the cheaper the strangle but the bigger move needed
  • Don't get greedy with your strike selection – a slightly more expensive strangle with closer strikes might have a much better chance of success