A strangle is the simultaneous purchase or sale of a call above the market and a put below the market.
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.
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.
Return to the main trading glossary page to learn more terms.