A Long Strangle strategy is an option buying strategy that includes buying 1 OTM (Out of The Money) Call option as well as 1 OTM Put option of the same underlying Stock/Index, at the same time and of the same expiry. This strategy is implemented when the underlying asset is expected to make a big move on either side. It is a Price neutral strategy which means that this strategy will make money irrespective of the price moving Up or Down.
Long Strangle-
A Long Strangle is a Naked option Buying Strategy, and by Naked option buying, it means that there is no Hedge involved in this strategy, if the view goes wrong then the result would end at a loss.
In a Long Strangle Strategy, A slightly OTM (Out of The Money) call option and a slightly OTM Put option is purchased at the same time, of the same underlying asset, and of the same expiry. The Ratio of the Call & Put option should be 1:1. This means if one buys 6 Call options then 6 Put options have to be bought for a long strangle.
This strategy is implemented when the underlying Stock/Index is expected to make a big move on either side but the direction is unknown. A long Strangle strategy is implemented before any big event like earnings release, election results corporate earnings, etc that can cause a big price movement and increase the IV (Implied Volatility that in result will increase option prices. It is a Delta-neutral strategy which means that this is a price neutral strategy that will work if the price of the underlying asset goes Up or Down.
How to Manage & Use-
Let’s see how to use a Long Strangle-
Assuming that the quarterly results of HDFC bank are to be announced tomorrow. It could be bad or could be great. As we expect either of them, a long strangle strategy can be used.
Let us assume that the spot price of HDFC Bank is- 2000 then to implement a Long Strangle A OTM call & put have to be bought.
Hence buy 1 2050 call @20.
& buy 1 1950 put@20.
- The maximum probable loss in this strategy can be- 40 (Total Premium Paid)
- Upper Breakeven- 2070-(Spot +Premium paid)
- Lower Breakeven- 1930 (Spot - Premium paid)
- Maximum Loss range- (2070-1930)
- Maximum Profit- Uncapped.
How to Adjust a Long Strangle-
A Long Strangle is a Delta Neutral strategy which means that the sum of the Delta of the Call option and Put option is 0. But if either of the Call or Put option becomes ITM (In The Money) then the Delta of the Particular option might change and that might disturb the profitability of the Strategy. This happens because as the overall Delta becomes Positive due to the movement of the stock, now as long as the underlying asset is trending in one direction it is good, but if it reverses due to volatility then one can lose the potential profits that are already there.
To prevent this from happening. One can book the existing positions and place another Long Strangle that is OTM (Out of The Money).
The only drawback of this strategy is that if the underlying Stock/Index does not move significantly or trades within a range till the expiry then the trader has no other option than to either book the loss or roll over the position to the Next Expiry. Apart from this, there is nothing that one can do to adjust to this strategy.
Conclusion-
To conclude, a Long Strangle is an excellent strategy when implemented in trendy markets are the profit potential in this strategy is unlimited, whereas if the underlying stock or index does not move significantly and trade within a range, the trader can face a loss but the maximum amount of loss is limited to the total premium paid for this strategy.