The Complete Book of Option Spreads and Combinations: Strategies for Income Generation, Directional Moves, and Risk Reduction, + Website

CHAPTER 8

Strangles

When we discussed straddles in Chapter 7, we described an option combination created by buying (or selling) a put and a call with the same strike price, usually the at-the-money strike price, and with the same expiration. Straddles are pretty expensive because to execute a long straddle you buy the two options that have the greatest amount of time value. If you’re selling a straddle, that’s good news; you’re selling the two most expensive options, in terms of time value, in that expiration month, but you’re pretty much assured of having one of your short options expire in-the-money, meaning you’ll have a position in the stock, a position that you might not want.

If you wanted to make money if the underlying stock experienced a big move but didn’t want to spend as much as a long straddle might cost, or if you wanted even more leverage than a straddle will generate, then you could buy out-of-the-money options; you could buy an out-of-the-money call, meaning that the strike price of the call is above the current price of the underlying stock, and you could buy an out-of-the-money put, meaning that the strike price of the put is below the current price of the underlying stock. This combination of an out-of-the-money call and out-of-the-money put with the same expiration date is a strangle. When buying both options we’re buying the strangle, when selling both options we’re selling the strangle.

A long strangle is a defined risk strategy that you might use when ...