Details about Long Strangle Option Trading
We have already covered Long Straddle Option Trading earlier. In this series of articles, we will cover another very commonly traded option combination called the Long Strangle.
The only difference between a Straddle and a Strangle is that in Straddle, an option trader selects same strike price for both Call and Put Options, while in Strangle, an option trader selects a different strike price calls and puts (OTM - Out of the Money), so as to form a range of profit area in strangle, instead of a triangular peak in straddle.
A strangle is considered to be a Volatility Strategy for options trading, and is very easy to understand, construct and trade.

Long Strangle Options Trading

What is a Long Strangle Option Trading?
A Long Strangle Options trading position is a NET BUY position where the option trader purchases 2 options - 1 OTM call and 1 OTM put, so as to form a extended or elongated payoff function. Since there are 2 BUY's involved, the option trader has to pay for these 2 options purchases and hence it is a net debit position. However, since OTM calls and puts are selected, the price paid is lower compared to that of a Long Straddle position. (Want to know what is ITM, OTM, ATM in Options? See Moneyness of Options - OTM, ATM, ITM Options)

In which scenarios should Long Strangle Option be traded?
Long Strangle Option can be traded in the following scenarios:
When the option trader is expecting an big price movement in the price of the underlying stock (or index). However, this is similar to Long Straddle trading scenario as well.
Then what is difference between straddle and strangle trading? The main difference is that in a strangle, since you purchase OTM calls and puts, the price you pay is going to be comparatively less compared to Long Straddle (where you purchase high cost ATM calls & puts).

So assume that IBM has expecting to come out with its earnings reports in next 2 months time and an option trader is expecting a big price movement in IBM's stock price which is currently at $50 - if the earning results are good, the stock will move to $100 and if the results are bad, it may come down to $10 (just an example).
Or, say MICROSOFT has bided for a government assignment project. If it wins the project, the stock price will move up from current levels of $30 to $60, but if it looses the project bidding then the stock price will fall down to $5 or so (another example).
Hence, these scenarios make a good case for taking up long strangle positions, that too with less money invested (as compared to long straddles)

One must note that since Long straddle is a net buy position, the position should be taken with good enough time to expiry at least 2-3 months to expiry (See how Options time decay erases money: Options Time Decay: Explained with Examples).

Instead of a long strangle or long straddle, you can also look for Long Gut Trading Position (Explained with example)

How to construct the Long Strangle Option Position?
A Long Strangle Option position can be constructed or configured by simply buying the OTM strike Call & Put Options with the SAME expiry on the same underlying stock or index.

Usually, the strike price selected are OTM - Out of the Money - call and puts. They should be selected such that the probability of the underlying stock price hitting the strike price is good enough. No point in selecting a way outside OTM strike price.
Say for e.g., if IBM is trading at $50 with a normal volatility which makes it fluctuate plus/minus $5 (i.e. in the range of $45 to $55) on a monthly basis. Since you are expecting big swing, you may like to take $60 call strike price and $40 put strike price options for constructing this long strangle on IBM options. Dont go for wide strike prices like $80 for call and $20 for put - chances of these wide strike prices being hit might be next to zero.

1) 1 * OTM Long Put
2) 1 * OTM Long Call
Theoretically, here is how it will look:


Let's now head on to next part Profit & Loss Calculations for Short Straddle Options Trading