Options QA

Options Strangle – An Example Using an ETF

If you’re interested in options trading, you may have heard of the strangle strategy. This complex strategy involves buying both a call option and a put option on the same underlying asset, with different strike prices but the same expiration date. In this article, we’ll demystify the strangle strategy using the SPDR S&P 500 ETF Trust (SPY) as an example.

What is a Strangle?

A strangle is a high-risk options trading strategy that’s used when a trader expects a significant price movement in the underlying asset, but is unsure of the direction of the movement. By purchasing both a call and a put option, the trader can profit regardless of whether the price of the underlying asset goes up or down.

How Does a Strangle Work?

Let’s say that Jeremy believes that there will be a significant price movement in SPY, but he’s not sure whether the price will go up or down. Jeremy decides to use a strangle strategy to capture the potential movement.

Jeremy buys a call option with a strike price of $430 and a put option with a strike price of $390, both expiring in one month. The current price of SPY is $410. Jeremy pays a premium of $5 for each option, for a total cost of $1,000.

If the price of SPY goes up, Jeremy will exercise the call option and make a profit. If the price goes down, Jeremy will exercise the put option and make a profit. If the price stays within the $390 to $430 range, Jeremy will lose his premium of $1,000.

Let’s consider some scenarios:

Scenario 1:

The price of SPY goes up to $440. Jeremy exercises the call option and makes a profit of $5 per share, or $500 total. He lets the put option expire worthless.

Scenario 2:

The price of SPY goes down to $380. Jeremy exercises the put option and makes a profit of $5 per share, or $500 total. He lets the call option expire worthless.

Scenario 3:

The price of SPY stays at $410. Jeremy loses his premium of $1,000, as both options expire worthless.

When to Use a Strangle?

A strangle can be a useful strategy when a trader expects a significant price movement in an underlying asset but is unsure of the direction of the movement. However, it’s important to note that a strangle is a high-risk strategy. The cost of purchasing both a call and a put option can be significant, and if the price of the underlying asset doesn’t move significantly, the trader can lose the entire premium paid.

Conclusion

In conclusion, a strangle is an options trading strategy that involves buying both a call option and a put option on the same underlying asset with different strike prices but the same expiration date. This strategy can be used in a variety of markets, including stocks, commodities, and ETFs. If you’re interested in options trading and want to use a strangle strategy, it’s important to understand the risks and be willing to take on significant risk. Happy trading!


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