Today, there are about 13.8 to 50 million stock traders worldwide — some of these are experts, some are beginners, and some are just learning.
Traders who are new to option strategies often start with basic ones like call and put, and many traders settle for this strategy throughout their trading career.
In essence, call options allow holders to purchase an asset within a specified timeframe at a stated price, while put options allow users to sell the assets within a specified timeframe at a stated price.
Generally, call-and-put options, with bullish buyers and bearish sellers and bearish buyers and bullish sellers, respectively, are used to make directional plays on a stock.
However, if you’re one of those few traders who want to embrace advanced options strategies due to how versatile and flexible they are, and are looking to move towards advanced strategies that can aid you with specified objectives, then welcome aboard.
First things first, you must understand how crucial it is to understand advanced strategies to their core.
Understanding these strengthens your position as an advanced trader and allows you to consider the risk potential involved within these advanced trades.
So, in this comprehensive guide, we will cover everything you need to know about one of the most used option strategies: straddles and strangles.
We will cover everything you need to know, from the basics to options straddles vs. strangles and how to choose and assess the risks.
Let’s begin!
What Are Straddles and Strangles Options
First, it’s important to understand what straddles and strangles options really are.
Unlike basic call-and-put strategies, straddle and strangle options are more advanced strategies for traders who expect stocks to substantially move higher or lower, regardless of the direction.
To understand this better, suppose a company is releasing its earnings reports on a stock you are following.
Or, perhaps it’s launching a product that might prove the greatest of all time or a huge flop for the company.
Either way, you will observe an impact on its stock price — the stocks will definitely have a shift in value.
However, you don’t know whether the change would be in a positive direction or a negative one.
That’s why straddling and strangling strategies exist.
Straddles and strangles both aid in the exposure of price volatility (vol).
Volatility exposure refers to how much intensity a specific asset, like stocks, is increasing or decreasing in value over a given period of time.
The straddle strategy involves buying or selling both a call and put option simultaneously that, too, with the same strike price as well as the date of expiration.
The goal is to make a high profit that comes from a high volatility in the underlying stock price, either up or down.
Moreover, there are two types of straddle options: long and short.
A long straddle involves buying, and a short straddle involves selling both, call and put of the same strike price simultaneously, with the same expiration date.
Through this option, you have the potential for unlimited profit while your loss is limited.
Similarly, yet differently, in the short straddle, the opposite is true – limited profit and unlimited loss.
On the other hand, a strangle strategy involves different strike prices but the same expiration period.
It’s the buying or selling of an out-of-the-money (OTM) call and put option.
Unlike the straddle option, strangle aims to make a profit from a significant shift in the underlying stock price regardless of the direction of the change.
When traders anticipate a significant shift in the underlying stock value regardless of the direction, they employ a long-strangle strategy to stay profitable.
In this strategy, the trader or investor buys a call at a higher strike price and a put at a lower strike price.
When the stock value changes significantly in either direction within the expiration date, the trader makes a profit.
However, as with the long and short straddle, the short strangle strategy is completely opposite of the long one.
When the trader anticipates minimal changes in the value of the stock, or when they anticipate the future volatility to be less than the current volatility in the stock price, they sell a call at a higher strike price and a put at a lower strike price.
The trader is going to make a profit if the stock price stays within the underlying strike prices till the end of the expiration date.
Similarities and Differences Between Straddles and Strangles
Both option strategies, straddle and strangle, have some general similarities.
For one, investors and traders implement these strategies based on the presence and lack of volatility to earn a profit.
Also, in both strategies, investors only have to anticipate the change in the underlying stock value, irrespective of its direction.
But that’s just as far as the similarities go.
The differences are as follows:
| STRADDLES | STRANGLES |
| The strike price and expiration period are the same. | Different strike prices but the same dates of expiration. |
| With any change in the underlying stock value, the net value of the option changes. | The net value of the option changes when there’s a larger shift in the underlying stock value. |
| Costly to employ. | Cheaper to employ. |
| No directional bias. | To some extent, there can be directional biases. |
Options Straddles vs. Strangles: The Long and Short of It
Directionally Agnostic Straddles and Strangles
Straddle and strangle strategies are directionally agnostic, which means that while trading, only the move’s magnitude is given importance instead of the direction.
That’s because when you buy an ATM straddle, you will buy both a call and put at the same underlying security with the same strike price.
Therefore, a change in the underlying stock value would offset the change in the call and put options, meaning if the stock price rises, the call will go up in price, however at the same time, the put will lose value.
Thus, it doesn’t matter whether the underlying stock price rises or falls- the total sum of change in straddle, also known as delta, will be close to zero.
Note: Delta is a ratio that compares the change in the value of an underlying asset, like stocks, with the change in the price of a derivative, like an options contract.
Delta values range from 0 to +1 and 0 to -1 for call and put, respectively.
Similarly, in a strangle strategy option, we can apply the same theory but with a slight change.
When you implement a strangle strategy and purchase a call and put option with an equivalent delta, such as a -0.20 delta put and a 0.20 delta call, the underlying value of the stock will have to change by a greater magnitude for you to make a profit.
For example, suppose you purchased an underlying stock at $50 per share with a call option strike price of $60, a put option strike price at $40, and paid a total premium of $2 for the option contract.
Now, to make a profit, the stock value has to rise or fall by $12 ($10+$2) or more before the expiration date.
If the stock value increases to $80 before the option’s expiration date, you will make a call surplus of $30 but a loss of $10 on put.
To calculate your profit, you will subtract a $10 loss and $2 premium fee from your $30 call profit.
Hence, your total profit will be $18.
Note: Since, in the case of strangling, the strike prices are not the same, and you can choose different strikes for call and put, there can be, to some extent, direction bias involved.
If you anticipate the underlying value to rise, you should keep the call low, and the put option high.
Choosing a Strategy: Options Straddles vs. Strangles
Now, the next most important thing is for you to see and understand which option is best for you.
The answer to this question generally depends on how much risk you are willing to take and what your goals are.
On one hand, long straddles are costly.
However, you will start making a profit when the underlying value moves further from the strike price (including the options contract fee).
On the other hand, a long strangle strategy is comparatively cheaper, as it’s based on OTM options.
However, making profits with this strategy is more difficult as it requires the underlying value to surpass the strike price with a much greater margin.
To help you understand this better, here’s a simple example: XYZ has an underlying stock price of $100 per share.
While employing a long straddle strategy at a strike price of $100 and expiration period of 30 days, you purchase a call and put option for $3 ($1.50 for call, and $1.50 for put), including transaction costs.
If, in 30 days, the stock rises or falls above the premium fee of $3, you are safe and making profits.
However, if the stock price rises or falls by less than premium fee ($97 < stock price < $103), you will be at a loss.
Although chances of success are greater with straddle strategy, in effect, it is more costly than the strangle option.
Moving forward with our example, let’s keep strangle strategy on the test.
Since strike prices for call and put options are different in strangle, we will strike call for $105 and put for $95, with a premium fee of $1.50.
For you to reach the break-even point, the stock price must rise to $106.5 ($105 + $1.5) or fall to $93.5 ($95 – $1.5).
Let’s say the stock price falls to $94 before reaching the expiration date.
The put profit will account for $1, while the loss from call will be the amount of the premium fee, which is $1.5.
Despite the stock price falling below the put strike price, you will make a total loss of $0.5 ($1 – $1.5).
So, while the strangle options strategy is cheaper than straddle, the success ratio is below 50%.
Overall, regardless of the success rate, there are some risks attached to both strategies.
Long Straddles vs. Strangles: Assessing the Risks
IV Drops
The biggest risk attached to either of these strategies is the post-earnings volatility crush or IV drops.
When a trader holds a straddle or strangle option while watching the stock move, it’s not easy to let go of the option and take whatever profit has been generated.
However, when the news is out, the volatility gets hit and falls as it reaches the expiration date, resulting in losing all the earnings.
So, while considering the risks, you must keep the pricing and its dynamics in mind.
Time Decay
Time decay, otherwise known as theta, is a shared enemy between both straddle and strangle option strategies.
Time decay is one of the major causes of losses, especially if the stock price remains stable.
That’s because, as time passes by, the value of the options decays, and unless the stock experiences a significant price movement, the chances of making a profit become very thin.
Therefore, holding an option for an extended period is not really a great strategy.
The Bid-Ask Spreads
The Bid-Ask spread impacts the cost of entering and exiting straddle and strangle options.
Bid is the maximum price an investor or a trader is willing to pay for purchasing an option, while the Ask is the minimum price a seller is going to accept.
The gap between these two prices, bid and ask, is known as the Spread.
When trading with straddles or strangles options, a wider bid-ask spread can lead to higher transaction costs, which reduces profits.
Therefore, to avoid this risk, you should aim to enter and exit options when the spread is narrow.
Also, note that wider bid-ask spreads make it difficult to execute trades at desired prices, impacting overall performance.
The Bottom Line
So, options straddles vs. strangles, which is better?
Both of these are advanced options strategies, which allow investors to make a profit by anticipating the volatility of a stock.
Choosing which one is best between both depends on how you approach the earnings reports.
That, in turn, depends on how you, as a trader, view market objectives and tolerate risks.
Now that you know how both these work, the only things you need to take care of are the risks you’re willing to take and the risks involved, i.e., IV drops, time decay, and bid-ask spreads.
Overall, you should opt for straddles when you’re unclear as to which direction the stock price will move in and strangles when you know the stock will move in some direction but still want to remain protected.
If you still have any questions regarding the subject, feel free to reach out to us here or check out our dedicated resources here.
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All the information made available here is generally provided to serve as an example only, without obligation and without specific recommendations for action. It does not constitute and cannot replace investment advice. We therefore recommend that you contact your personal financial advisor before making a purchase decision.
