Exploring the Risk/Reward of Strangle Options Trading

Options trading can be a lucrative and rewarding form of investing if you understand the associated risks and rewards. One of the more complex strategies for options trading is the strangle, which entails simultaneously selling a call and put option that are both out of the money. With this article, we’ll look at the basics of strangle options trading and explain the function, risk, reward and profit/loss calculations that relate to this advanced strategy.

One of the key elements of options trading is the concept of implied volatility. Implied volatility is essentially an estimate of the range in which the stock underlying the option may trade in. This is a crucial concept when talking about strangle options trading since it will determine the strike price and the premium of the options.

Both the call and put options of a strangle trade are both out of the money, meaning the strike price is lower than the current stock price for the call option and higher than the current stock price for the put option. As with any form of options trading, the options buyer wants the underlying stock to move into the money to breakeven, and then past the breakeven to be able to make a profit. The farther the stock moves, the higher the reward.

Once you understand the basics of the strategy, you must then understand the risks and rewards involved. For example, there is the concept of time decay with option contracts. What this essentially means is that, as time passes, an option premium is continually falling. This must be taken into consideration as strangle positions must be open for a particular amount of time to maximize any profits.

Also, market volatility presents a risk for strangle positions. With more market volatility, the less time premium an option has, meaning there is less time to get the underlying stock to move into the money. So, when assessing the risk of a strangle option, it is important to consider the levels of implied volatility in order to estimate potential rewards and risks.

Finally, proper risk management needs to be applied to any options trading strategy. With strangles this includes adding further positions, or rolling options to different strike prices and expiry dates. This also includes taking profits when you can as well as cutting losses.

We’ve just touched upon some of the basics involved in strangle options trading. If you are interested in exploring the strategy further, we recommend using MarketXLS’s Strip Straddle Template. Also, check out this article to get a better understanding of how the implied volatility of a stock can affect the strangle strategy.

With the right knowledge, strategy and risk management, strangle options trading can be a great way to add to your portfolio. As always, be sure to do your own research and get acquainted with the risks and rewards associated with this strategy.