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What is Strangle in Option market?


Strangle: It comes under neutral strategy. Strangle is same as straddle but the only difference is the strike price of put and call option is out of the money.

Long strangle: In long strangle the call and put option have different strike price and the premium paid is low if the investor buying a call and put option he has to pay low premium. In this case both options are out of the money.

Maximum Profit = Unlimited
Maximum Loss = Net premium paid + commission paid
Break-Even Point = Strike price of Long call + Net premium received    (Upper break-even point)
Strike price of long put – Net premium received                                       (Lower break-even point)

Example: Suppose Company XYZ stock traded at Rs.7200 and stock prices move in either upward or downward direction. How to gain in option market by using long strangle?

Solution:
 If the current market price of a stock is Rs.7200 and the investor buys a call option at Rs.7500 and the premium paid is Rs.120 and put option at Rs.6900 and the premium is Rs.132. If the stock price remains same then no option will exercise and the premium paid for buying an option is the maximum loss. In this case maximum loss will be Rs.252. If the price increases to Rs.7600 then only the call option is exercised and the investor earn on call option - Rs. 20 (7600-(7500+120)) and from put option –Rs.132. So, the net loss will be Rs. 152 (-20-132).
If the price of a stock is decreases to Rs.6500 then put option contract will exercise and the investor earn Rs.268 (6900-(6500+132) from put option and -Rs.120 from call option. So, the net profit is Rs.148 (268-120).

Short strangle: It is just opposite of long strangle and the strike price of call and put option are out of the money.  The investor writes a call and put option at different strike price but with same expiration date.

Maximum Profit = Net premium paid - commission paid
Maximum Loss = Unlimited loss
Break-Even Point = Strike price of short call + Net premium received    (Upper break-even point)
Strike price of short put – Net premium received                                      (Lower break-even point)

Example: How to use short strangle where strike price of short call is Rs.7300 for Rs.125 and short put is Rs.6800 for Rs.125. If the current stock price is Rs. 7000 and the stock price move in either direction?

Solution:

The current market price of a stock is Rs.7000 and the investor writes a call option at Rs.7300 and put option at Rs.6800 and the total premium received (net credit) Rs.250 If the stock price increases Rs.7600 then the short call will become in the money option and the intrinsic value and net profit will be Rs.300 and Rs.50 respectively. If the price decreases to Rs.6900 then only put option is exercise and the net loss is Rs. 150 (7000-(6900+250).
If the prices of stock still same on expiration date then both the option expires worthless and the premium received is the profit for investor that is Rs.250.

* Always remember that as an investor you receive premium on short option only whether it is call and put option.



Comments

  1. Phani KumarJune 22, 2020 3:27 pm







    Hey, thanks for the information. your posts are informative and useful. I am regularly following your posts.
    Axis Bank,
    Phillip Capital,
    Jefferies,



    ReplyDelete

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