Strangles: A strangle consists of the simultaneous purchase (a long strangle) or sale (a short strangle) of a call and a put on the same underlying security with different strike prices and/or expiration dates. The example provide below is a Strangle with different strike prices with the same expiration. The concepts of the strangle are very similar to the concepts of a straddle.

As a buyer of this strangle, we have to chose which strike price we want. We will use the 45C/40P. This means that we are buy a call option with a $45 strike price and also buying a put option with a $40 strike price. There is a little more risk in using a strangle position because there is a dead zone where you will make no money. With the stock price at $41.85, the dead zone with this stock is between $40 and $45. In this case, we would pay $2.00 to establish this position.

In order to profit from this transaction as a buyer, the stock price must either exceed $45, where you will profit from the call option, or the stock price must drop lower than $40, where you will profit from the put option. Once again, this is good for high volatility plays. Generally, if using the same expiration but different strike prices, the strangle will tend to cost less than the straddle because of the “dead zone” that exists in the strategy. The size of the dead zone depends on the stock price and how the options are priced. Since our stock is priced in a reasonable zone, the spread is only $5. Stocks like Google that trade in the $500 rage have a spread of $10. Stocks that trade under $10 generally have a spread of $2.50.

As a seller of this strangle, we would receive $1.80 from the buyer. Our maximum profit range will occur if the stock price expires between $40 and $45. Since we receive the premium from a buyer, our true range at expiration is from $46.80 or $38.20. At either extreme, we will make a profit of $0. Once again, we hope for little volatility but the range for making the maximum profit is much wider than the straddle, where the maximum profit is obtained if the stock closes at the strike price.