Straddles and strangles are two of the more popular options strategies investors use . We’ll explain the strategies in detail to help you understand which may be best for you and what market conditions are best for each strategy.
Key similarities and differences
Both strategies consist of buying or selling a call option and a put option. Straddles and strangles can be credit or debit strategies. The main difference is whether you are buying or selling the options, which greatly impacts the strategy’s outlook, risk, and profit potential.
Long straddles and long strangle strategies look for a significant price move in either direction, while short straddles and strangles seek stocks with minimal movement.
Straddles
A straddle involves buying or selling a call and a put at the same strike price and expiration date. Straddles are typically entered at-the-money.
Short straddle
A short straddle consists of selling a short call and a short put at the same strike price for the same expiration date. The strategy capitalizes on minimal stock movement, time decay, and decreasing volatility.
Short straddles have limited profit potential and undefined risk. The combined credit of the short call and short put is the maximum profit for the trade. The maximum risk is undefined beyond the position’s break-even price.
Long straddle
A long straddle has a similar setup as a short strangle, but instead of selling the options, you buy an at-the-money call and put.
Long straddles are successful if the underlying asset makes a large move or volatility rises significantly. Because a call and put are purchased, the direction is irrelevant. However, the stock must move enough to exceed the break-even point, which is the combined cost of the two options.
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Strangles
Like straddles, strangles involve buying or selling a call and put option. However, the two options are out-of-the-money. Therefore, the premiums are lower, so purchasing a strangle is less expensive, and selling a strangle collects less credit.
Short strangle
A short strangle consists of selling a short call option and a short put option with the same expiration date. The short options are typically sold above and below the stock price. The combined credit received for selling the two options defines the maximum profit for the trade. Be aware that the maximum risk is undefined beyond the credit received.
Long strangle
Long strangles and long straddles are similar in objective: they depend on large directional moves and increased volatility. Like the long straddle, your risk is defined by the initial cost to enter the position. Because the options are out-of-the-money – unlike ATM straddles – the underlying asset will have to move much higher or lower to be profitable.
The benefits of using a straddle or a strangle
The main benefit of selling a straddle or strangle is you can capitalize on little or no price movement if a stock is trading sideways. The advantage of buying these neutral strategies is you don’t have to pick a direction – you’ll profit if the underlying asset makes a large move up or down, or volatility increases significantly.
Another benefit is that these strategies can be used to hedge your portfolio. For example, if you're bullish on a stock but worried about a short-term pullback, you could buy a straddle to protect your position.
Short straddles and strangles can be converted into an iron butterfly or an iron condor to define risk.
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