The strangling I’m referring to has to do with options trading. For simplicity sake we’ll refer to it as the strangle option.

The Strangle Option Defined

The long strangle option consists of the purchase of a call and put with different strikes (higher strike to the call, lower strike to the put) and the same expiration date. Long strangle option traders profit in 1 of 2 ways: 1) An increase in option implied volatility or 2) the underlying stock moves far enough in one direction to where the delta gain of the closer strike option outweighs the delta loss of the further strike option. A short strangle option would consist of the sale of a call and put with different strikes and the same expiration date. Short strangle option traders profit in 1 of 2 ways: 1) option implied volatility declines, or 2) the underlying stock trades in a relatively small range and the trader collects time decay (theta). A payoff diagram for a long strangle option is illustrated below:

Strangle Option vs. Straddle Option

The strangle option is the brother of the more popular straddle option. A long straddle consists of the purchase of a call and put with the SAME strike (typically at the money) and the same expiration date. Straddles carry a higher price tag than the strangle option due to the call and put having maximum optionality value being at the money. Thus, the maximum loss attributed to a long straddle position is greater than the maximum potential loss of a strangle option. A short straddle consists of the sale of a call and put with the same strike and the same expiration date. The payout structure of the long/short straddle Is similar to that of the strangle option with the major difference being the distance from the strike the underlying stock needs to move (or not move) by expiration for the straddle position to yield a profit. A payoff diagram for a long straddle is illustrated below:

Long Strangle Option Strategy

The type of strangle option strategy an options trader uses is governed by his volatility bias. If he thinks the implied volatility of the option is cheap and expects the stock price to move significantly one way or another (the beauty of the long strangle option is not having to pick a direction initially) then he would go long the strangle option. I typically target a strangle option with 60 days until expiration and target a 20% return. As part of my risk management practice I sell out of my long strangle option position at a max loss of 20% or 3 weeks before expiration whichever comes first. The time decay of the strangle option increases exponentially in the last few weeks of expiration making long option holders wary of holding positions overnight and especially over weekends.

Short Strangle Option Strategy

If you think option implied volatility is destined to fall over the 60-day term and that the stock will remain within a narrow trading range, then you should consider a short strangle option strategy. Under this strategy the short strangle options trader generates daily profit as the position loses value through time decay. Short strangle option strategies are difficult to put on for small retail investors as margin requirements make the strategy only really feasible for institutional accounts. However there is a way to decrease the margin requirement by purchasing options at strikes at a greater width than the original strikes – the iron condor strategy. I’ll touch on this strategy in a follow-up post.

For further information on the Strangle Option and other Options Trading Strategies visit OptionsUniversity.com.