Do you believe a stock is set to move sharply in the next few days, weeks or months? You don’t have to guess the direction if you initiate a strangle or a straddle. These options trading strategies reward traders for dramatic price movements. While you have to correctly guess the direction if you buy one call or one put, strangles and straddles require that you purchase one of each contract. If a trader can only choose between a straddle or strangle, which one should they choose? This in-depth analysis of strangle versus straddle options can help you make a better decision.
What Is a Straddle?
A strangle is an options trading strategy that relies on a sharp price movement to achieve profitability. The trader starts this position by purchasing one call and one put with the same strike price and expiration date. A strangle loses its value if a stock’s price stays the same.
What Is a Strangle?
A straddle is similar to a strangle. This options trading strategy involves a call and a put, each with different strike prices. The trader profits if the stock swings sharply in either direction, but the straddle will lose value if the stock stays flat or barely moves.
What Is Level 3 Options Trading?
Not everyone can trade strangles and straddles. You need a Level 3 options trading account with your brokerage to use these strategies. Options brokers have tiers in place to determine which options trading strategies you can use. Level 1 options traders can only sell covered calls, while Level 5 options traders can use any strategy.
Level 3 options trading acts as the middle ground and lets you access most of the strategies. Strangles and straddles are part of this account, but you can also access condors, butterflies, vertical spreads and other strategies.
5 Differences Between Strangle and Straddle
Strangles and straddles are similar, but they have a few key differences.
Strike Prices
The strike prices for a straddle’s calls and puts are the same. If the trader buys a call with a $70 strike price, the put will also have a $70 strike price. The options in a strangle have different strike prices, and the call always has a higher strike price. For a strangle, a trader may buy a call with a $75 strike price and a put with a $65 strike price.
Cost to Implement
A straddle costs more money to set up than a strangle. Straddles use strike prices near the money or at the money. Options traders who use strangles buy a call and put that are both further out of the money. Because these two options are further out of the money, their premiums are lower. That’s why it costs less money to set up a strangle than a straddle.
Regardless of which one you pick, it’s important to keep commissions in mind. Many brokers charge a fee for each option trade. You may have to pay a fee to purchase a call and then another fee to close the position. This can get frustrating and meaningfully bite into your profits, especially if you want to open up multiple straddles and strangles. Traders should look for options brokers that have lower fees to reduce their expenses.
Directional Bias
Straddles and strangles both benefit from sharp price movements in either direction. The directional bias depends on how you set your strike prices, but significant movements will help both positions. Straddles have some variance based on how far out of the money you go with each position.
Assume a stock is priced at $100 per share. An options trader can initiate a strangle by purchasing a call with a $105 strike price and a put with a $90 strike price. It’s better for the trader for the stock to go up $7 than decrease by $7. The call is in the money is the stock price reaches $107, while $93 per share results in the put expiring worthless..
Amount of Change
An option experiences more dramatic price swings if it is out of the money. While straddles typically involve options near or at the money, strangles traders buy a call and put further out of the money. A straddle can go through a quicker change in value.
Potential Profit
A strangle has greater profit potential than a straddle. It achieves breakeven sooner than a strangle because those options are at the money. Straddles have a lower cost, which is useful in case the options expire worthless. However, a strangle has greater profit potential.
Tips on How to Choose Between Strangle and Straddle
When deciding between a strangle and a straddle, it's essential to understand the nuances and potential outcomes of each strategy. Both options can be advantageous depending on market conditions and your investment goals. To effectively navigate this decision, consider the following tips that outline key factors to evaluate. Each subheading will provide more detailed insights to help you make an informed choice tailored to your trading style. By analyzing these aspects, you can better determine which strategy aligns with your risk tolerance and market expectations.
Market Outlook Assessment
Before choosing between a strangle and a straddle, evaluate your outlook on the underlying asset. If you anticipate significant price movement in either direction but are unsure of the direction, a strangle, which involves buying out-of-the-money options, may be the cheaper option. Conversely, if you expect high volatility and are confident in a move around the current price level, a straddle, which involves buying at-the-money options, might be more appropriate.
Cost Consideration
Analyze the premium cost associated with each strategy. Straddles typically carry higher premiums due to their at-the-money positioning, while strangles are generally less expensive because they are out-of-the-money options. Weigh the potential for profit against the cost; if budget is a concern, a strangle may offer a more economical choice.
Volatility Expectations
Consider implied volatility in your decision-making process. If implied volatility is high, opting for a strangle could be more beneficial as it allows for a wider price movement range with less upfront capital. However, if volatility is low and you anticipate it increasing, a straddle might be advantageous as it captures rapid price changes near the current level.
Risk Management Goals
Assess your risk tolerance and goals. Straddles typically provide more symmetry in potential outcomes, as they involve buying options at the current market price, making them less risky for sudden price movements. Strangles, on the other hand, involve higher risk but can yield substantial rewards if price movements are pronounced enough to exceed the lower initial investment.
Time Horizon
Consider your time frame for the trade. If you expect an imminent significant event or price movement (like earnings reports), a straddle could be better suited since it allows you to capitalize on quick volatility moves. If you expect developments over a longer period, a strangle might afford more flexibility and reduce upfront costs while still providing exposure to potential price shifts.
Frequently Asked Questions
Which is better: straddle or strangle options?
A straddle is a simpler option to begin with since the premiums are lower, making it more beginner-friendly; on the other hand, strangles provide a higher potential for profit due to their broader range of price movement.
Which is safer: straddle or strangle?
Straddles are usually seen as safer because they involve buying options at the same strike price, which reduces the chance of losing on both positions. On the other hand, strangles can carry more risk since they need bigger price shifts to be profitable.
Which is more profitable: strangle or straddle?
When comparing profitability, a strangle may be more advantageous due to its lower upfront premium and ability to benefit from significant price changes. In contrast, straddles have a lower initial cost but may restrict profits if the underlying asset does not fluctuate much.
About Marc Guberti
Marc Guberti is an investing writer passionate about helping people learn more about money management, investing and finance. He has more than 10 years of writing experience focused on finance and digital marketing. His work has been published in U.S. News & World Report, USA Today, InvestorPlace and other publications.