Neutral

This position consists of both a long put and a long call, each sharing the same expiration date, but differing strike prices.

Long strangles are comparable to long straddles in that they profit if the market move significantly in either direction.

Application

The Investor will generally use a strangle when he or she is neutral on the underlying, however, because each leg  is purchased at different strike prices, one may favor a direction slightly.  This ultimately depends on how close each leg is to the current stock price.  The Strangle is usually established by purchasing both an out-of-the-money call and an out-of-the-money put with the stock centered in between the two.

Benefit

The strangle purchase will result in large potential profits if the underlying moves far enough in either direction.  Because this position is established using strikes prices  surrounding the actual stock price, the investor can maintain his or her neutrality.  A direction might be favored by choosing an option strike price closer to the underlying on one side.  

Risk vs. Reward

Maximum Profit: Unlimited

Maximum Loss:  Limited Net Debit Paid

Upside Profit at Expiration:
Stock Price - Strike Price - Premium Paid or
Strike Price - Stock Price - Premium Paid 

Volatility

The Implied volatility of an option is a measure of the amount by which the underlying security is expected to fluctuate over a period of time.  It reflects the markets expectations and can change at any time based on news or other events affecting the stock.

Volatility Increases:  Positive
Volatility Decreases: Negative

The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value premiums. The net effect on the strategy will depend on whether the options are in-the-money or out-of-the-money, and the time remaining until expiration.

It is suggested that this strategy be applied to stocks that have the potential or volatility to move significantly in a relatively short period of time.  Earnings announcements are ideal for applying this neutral strategy.

Time Decay?

Passage of Time: Negative

It is important that the underlying stock is capable of a significant move over the life time of the option.  Both legs of this strategy are subject to time decay.  If the stock remains relatively unchanged, the option's premium will decay and expire worthless 

Before expiration?

A strangle may be offset in one transaction, or "legged" out of, depending on the value of the position. If there is significant time remaining before expiration, the investor may exit the profitable side and remain holding the opposite position for free.  

The strangle holder will generally exit the position well before expiration, capturing as much of the profit as possible.

An Example

Similar to the long straddle, the strangle has an unlimited profit potential on both the upside and downside. If Symantec Corporation (SYMC) is trading at approximately $20.00 per share. The investor would purchase the $17.50 puts for $0.20 and the $22.50 calls for approximately $0.25. 

The Strategist could buy the $17.50 put for $0.20 and the $22.50 call for approximately $0.25. The out-of-pocket cost (and maximum loss) would be $0.45 or $45.00 plus commissions. The maximum loss of $45.00 ($0.45 x 100) would occur with the stock price remaining between $17.50 and $22.50.  The position would begin to show a profit with the stock below $17.50 and above $22.50.

The value upon expiration would vary depending on what the price of the underlying was.

It should be noted that, although this strategy can be created for less than the straddle, the stock must make a greater move in either direction in order to break-even.