The Strangle option strategy is a relatively low risk way to profit from an extremely bullish OR bearish outlook.
Option Trading Subjects:
Strategy: Strangle Purchase
The Outlook: Extremely Bullish OR extremely Bearish. Usually expecting a stock to either continue an up or down move OR reverse. Or expecting a dramatic move in the stock, but with the direction unknown, such as when positioning before an earnings report.
The Trade: Buy equal numbers of call(s) and put(s) using a strike price higher than the current stock price for the calls, and lower than the current strike price for the puts.
Gains when: Stock moves lower, past the lower breakeven, or stock moves higher, past the upper breakeven.
Maximum Gain: unlimited to the upside, limited by the stock falling to zero to the downside.
Loses when: Stock does not move beyond one of the breakeven points.
Maximum Loss : Limited to the initial debit.
Breakeven Calculation: Lower breakeven = put strike price - half of total debit. Upper breakeven = call strike price + half of total debit.
Advantages compared to stock: Increased leverage, much less capital required, "built-in" stop loss, don't need to pick a direction of movement.
Disadvantages compared to stock: Greater risk of 100% loss of the capital invested, more stock movement needed to gain.
Volatility: after entry, increasing implied volatility is positive.
Time: after entry, the passage of time is negative.
Margin Requirement : None. Initial debit must be paid in full.
Variations: Buy puts at the higher strike and buy calls at the lower strike. Both options will start off ITM instead of OTM, there is a much higher initial debit, but the position is otherwise the same.