The first thing you have to know about these strategies is that there are two options contracts for future delivery – calls and puts. A call option gives the bearer the right but not the obligation to buy a futures contract at a predetermined price within a specified period.
A put option gives the owner the right but not the obligation to sell futures at a predetermined price within a specified period.
They also work similarly concerning buying them – they can be helpful tools gained by exchanges or online brokers. Once you have a good idea of what a call and put option entails, you can begin to think about straddles and strangles.
These two popular options trading strategies are very similar but have their differences.
A long straddle options strategy involves buying both a call and put with the same strike price and expiration date.
Because investors cannot accurately predict how volatile or calm market conditions will be in the future, they can open up their options portfolio for flexibility by purchasing long straddles.
The amount it will cost an investor to buy one of these contracts can vary depending on several factors, including the strike price, expiration date, volatility and several other factors.
Because this is a long position strategy, the investor could pocket significant gains if the underlying asset experiences large movements either up or down.
It can be an effective strategy when opening many different kinds of investments at once. It cuts down on transaction fees since you are opening two positions instead of one.
The strangle option strategy involves buying both call and put options with different strike prices but the same expiration date.
An example would involve buying a call with a 30 dollar strike price for 25 dollars per contract and purchasing a put with 60 dollar strike price for 50 dollars per contract.
The goal is to make money off any significant change in the underlying asset price, especially if it is done dramatically. Lower volatility will lead to smaller gains but lower risk because two contracts are involved.
It is possible to lose money with this strategy because you have more than one contract. The goal is to increase volatility since there will be a more significant gap between premiums paid and premiums received for each position.
Straddles and strangles have their advantages and disadvantages, so let’s compare them side by side:
- There is a lower cost to initiate since there is no need to buy two options but only 1 of each.
- The maximum risk on a strangle is limited to the purchase option cost. At the same time, a straddle could have potentially more considerable losses if all options expire out of the money.
- Maximum loss potential is twice as high for a strangle compared to a straddle since a strangle needs both options to expire in the money, whereas only one option is needed with a straddle to be profitable.
- Both strategies have limited profit potential (stocks price must be within the range between strikes). A big move higher or lower than this range will lead to an unlimited loss with either strategy.
As you can see, these two popular options trading strategies do not go hand in hand, and they should be used depending on your risk tolerance.
If you are willing to accept the higher possible losses in exchange for potentially unlimited gains, then a strangle may be an option strategy that is right for you.
If you want to limit your maximum loss while possibly making more money in general, then a Straddle could be right up your alley.
It’s essential to understand how these two popular options trading strategies work so you can use them in different ways when needed or not at all when desired.
Link to Saxo broker Dubai for more information.