Contrarians like to fade trade, whereby they look for prices to reverse. Sharper moves in price, whether up or down, tend to be unsustainable, which makes them prime candidates for fade trades. In these cases, the trader wants prices to change direction since the current rally or decline is expected to end or see some short-term interruption.

Option sellers use these price spikes to sell puts into weakness in the underlying asset, and sell calls into strength in the underlying asset, due to the inflated prices of the respective options.

Option buyers prefer to buy calls into weakness in the underlying asset and buy puts on strength in the underlying asset, due to the reduced prices of the respective options.

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A strangle is the simultaneous purchase or sale of a call above the market and a put below the market.

Long Strangle

A long strangle involves the purchase of both an OTM put and an OTM call.  This strategy is generally utilized when the underlying stock or index is expected to make a very large move, but a direction is unknown.  By purchasing both options, the time value of both options begins to erode, so this is an approach often used when an event is expected to spark a sudden move (earnings release, economic data news, conference call, etc.).   A long strangle creates a negative Theta position.

A large move would cause the call or put to go ITM, and a move with great velocity could inflate the volatility component of price as well.  Because only one of the options (either the call or the put) can potentially expire ITM, a strangle buyer needs one option to gain more value than the other side loses in order to turn a profit.

Short Strangle

A short strangle is the sale of both an OTM put and an OTM call.  This strategy is generally utilized when the underlying stock or index is expected to stay within a price range, therefore allowing for the collection of premium on both the call and put sides.  This approach embraces the idea that the time value of both options will begin to erode, therefore creating a positive Theta position.

It’s common to sell strangles around scheduled events (such as earnings announcements) when a big move is expected and implied volatility is high and a contraction in IV is likely.  This causes rich premiums which quickly erode if price stays within the expected range.

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