Learning trading methods might be daunting for beginners. Traders often utilize the strangle. We will define a strangle, explain how it works, and provide recommendations for novices who wish to use it in their trading plan.
Defining Strangle
Strangles entail purchasing call and put options with the same expiry date but different strike prices. A strangle aims to benefit from large price changes in the underlying asset, regardless of direction.
A strangle lets traders benefit from volatility without assuming a directional bias, unlike directional methods like purchasing call or put options. This makes it appealing to traders who expect a big price increase but are unclear of the direction.
How Do Strangles Work?
To comprehend a strangle, examine an example. Suppose XYZ Company’s stock is $100 and you think an earnings release would cause a big price change next month.
A strangle strategy involves purchasing a call option with a $110 strike price and a put option with a $90 strike price. Both choices expire one month. Strangulation occurs when you buy both options.
If the stock price rises to $120, your call option will be in-the-money, letting you profit. Also, the put option will expire worthless.
However, if the stock price drops below $80, your put option will be in-the-money, enabling you to profit. The call option will expire worthless.
If the stock price swings considerably in either direction, the strangle position will profit from the winning option surpass the loss from the expired option.
Tips for Beginners
Tips for novices contemplating the strangle strategy:
Choose the proper asset: Not all assets are strangleable. Strangles need large price changes, therefore choose volatile assets.
Select suitable strike prices: Strangle success depends on striking pricing. Ideally, strike prices should be outside the stock’s trading range. This raises the likelihood of a big price change.
Manage risk: Strangles, like any trading method, need risk management. Calculate your risk tolerance and create stop-loss orders.
Understand option pricing: Understanding option pricing and how time decay and implied volatility impact it is crucial.
Beginning traders may use the strangle technique by following these suggestions and managing risk.
Sources and Links
Sources for this article include:
Smith, John. “Options Trading: The Ultimate Beginner’s Guide with Proven Strategies.” Wiley, 2019.
Investopedia. “Strangle Definition.” See https://www.investopedia.com/terms/s/strangle.asp.