Lesson 11: What are long straddles and long strangles?
Learn about long straddles and long strangles, how they differ and their associated risks.
CIBC Investor's Edge
A long straddle is a strategy involving the simultaneous purchase of a call and put option with the same strike price and expiration date on an underlying stock or ETF. Both options are typically at-the-money.
A long strangle involves the simultaneous purchase of a call and put option with different strike prices but the same expiration date on an underlying stock or ETF. The options are typically out-of-the-money with strike prices equally distant from the current stock price.
The goal is to sell the straddle or strangle later for a profit by correctly anticipating a substantial move in the underlying's price in either direction.
When to use these strategies
These strategies are often used when you're unsure about the direction of the underlying stock but expect a significant price movement. They also benefit from an increase in implied volatility. Traders often buy these positions using shorter-dated options before events like earnings announcements to speculate on the outcome.
The goal of both long straddles and long strangles is to profit from the future volatility of the underlying stock, without a directional bias. If the stock makes a large move up or down, one option will increase in value while the other decreases. Hopefully, the move on one side more than offsets the loss on the losing side, creating an opportunity to sell the positions for a profit before expiration. The underlying stock also needs to move enough to offset the cost and time decay of the straddle or strangle — this can require substantial volatility.
Buying either strategy involves paying premiums for both the call and put options, with the total cost dependent on the cost of the premiums and the number of contracts purchased, plus commissions.
When considering either trade, factors to keep in mind include finding an underlying stock with the potential for a significant price movement and increased implied volatility. Choose an appropriate expiration date that should align with your expectations for when the price will move.
How to place the trade
To build a long straddle, select an underlying stock or ETF, choose an expiration date, and buy a call and put with the same strike price, typically at-the-money. You can execute a straddle as a multi-leg order or leg into it by opening one leg first and the other later. You’ll pay a net debit to open the position.
To build a long strangle, select an underlying stock or ETF, choose an expiration date and two separate out-of-the-money strike prices, one for the call and one for the put. The strike prices are typically approximately equal distances from the current stock price. You can execute a strangle as a multi-leg order or leg into it by opening one leg first and the other later. You’ll pay a net debit to open the position.
Buying a straddle or strangle: Multi-leg strategy (MLS)
You can purchase a straddle or a strangle as a multi-leg trading strategy by specifying the net price you want to pay: the combined cost to you of the call and put you’re buying. Both parts of the trade have to be filled at the same time, at the price you specify or better. If those conditions aren’t met, the trade won’t execute. In essence, it’s a form of a contingent order — both parts get filled or neither do.
You may receive a partial fill on a straddle or strangle, but only in the ratio that you’ve specified. For example, if you’re buying 2 calls and 2 puts, you may be partially filled on 1 call and 1 put. Your fill will always reflect the specified ratio — in this example, 1 put for every 1 call.
Buying a straddle or strangle: Single-leg strategy
With this trade style, you place your order for the calls and puts as separate orders. This can be done consecutively, if you’re looking for an opportunity to secure a more advantageous price on one or the other side of the trade, or simultaneously.
This is also known as “legging in” to a strategy.
How do straddles and strangles differ?
Here’s a summary of the main differences between these trading strategies:
Same strike price for the call and put options
Different strike prices for the call and put options
Typically uses at-the-money options
Typically uses out-of-the-money options
More reactive to price changes in the underlying asset
Less reactive to price changes in the underlying asset
Typically, more expensive
Typically, less expensive
Higher theoretical probability of success
Lower theoretical probability of success
One option typically has some value at expiry
Both options may expire worthless
Holds a larger percent of its value over time, assuming all else remains constant, a positive for the long straddle holder
Holds a smaller percent of its value over time, assuming all else remains constant, a negative for the long strangle holder
How do you make money from a straddle or strangle?
Both positions benefit from significant and rapid movements in the underlying stock price. They also profit from an increase in implied volatility, assuming other factors remain constant. As the expiration date approaches, time decay accelerates, causing both the call and the put options in the straddle or strangle to lose noticeable time value each day. At expiration, the options will only be worth their intrinsic value.
To maximize profits, it’s important to decide whether to sell the straddle before expiration or hold it until then. Selling before expiration helps to capture any profits and avoid further time value decay. However, waiting too long may result in offsetting movements in the stock price and your profit may be reduced or disappear.
A stable, sideways-moving stock price and decreasing implied volatility can negatively affect the value of a straddle or strangle. For the strangle, if both options are out-of-the-money at expiration, the trade will result in a complete loss of the premiums paid to purchase the options. With a straddle, one position will typically maintain some value at expiry unless the underlying closes exactly at the strike price at expiry. However, the value at expiry may be very low if the underlying closes near the strike price and a sale may result in a net debit to you when commission is factored in.
How to close a straddle or strangle
Closing the position can be done by selling both the long call and put simultaneously, preferably at a net credit compared to the initial purchase price.
Alternatively, it’s possible to leg out by selling one option first and the other option later. This approach can help manage liquidity concerns or adjust the strategy structure. It can also have a detrimental effect, as any loss in one side of the position is no longer offset by a potential gain in the other side.
Exercising the options before expiration is possible but may not be beneficial. Exercising results in the loss of any remaining time value, which may be a detriment. However, there are specific scenarios where early exercise might make sense, such as capturing an upcoming dividend payment or ensuring the intrinsic value of the option is realized. This could be considered when one side of the straddle or strangle is deep-in-the-money.
Holding the position until expiry
Holding the position until expiration carries risks and can lead to a maximum gain or loss outcome. If both options expire out-of-the-money, they will be worthless, resulting in a complete loss of the original straddle or strangle purchase price. If one option expires in-the-money, it may be automatically exercised, while the other option expires worthless. In some cases, automatic exercise may result in you unintentionally holding a long or short stock or ETF position after the straddle or strangle position has expired, which could result in additional losses to you. It may put you into a margin call if you don’t have enough equity or cash to cover the additional margin requirement of holding the stock position. If you don’t want exercise to take place, you may need to take action and contact us to ensure that doesn’t happen.
The long straddle can make money in two different scenarios — if the stock closes below the downside breakeven point or above the upside breakeven point. The upside breakeven is equal to the chosen strike price plus the total premium paid. The downside breakeven is the chosen strike price minus the total premium paid.
The long strangle can make money in two different scenarios — if the stock closes below the downside breakeven point or above the upside breakeven point. In the long strangle, the upside breakeven is equal to the chosen call strike price plus the total premium paid. The downside breakeven is the chosen put strike price minus the total premium paid.
In addition to possible automatic exercise, explained in the previous section, corporate actions, such as stock splits, reverse stock splits, mergers, or acquisitions, can impact the underlying stock and subsequently affect the options held. These actions may cause changes to the option's structure, price, or deliverable. Be sure to stay informed about any corporate actions that may impact your positions. You can do this by regularly checking both your account holdings and any news on the stock.
Please remember that it’s your responsibility to verify that your holdings continue to reflect the objectives of your chosen trading strategies.