LONG STRANGLE
A Strangle is a slight modification to the
Straddle to make it cheaper to execute.
This strategy involves the simultaneous buying of a slightly out-of-the-money
(OTM) put and a slightly out-of-the-money (OTM) call of the same underlying
stock / index and expiration date. Here again the investor is directional
neutral but is looking for an increased volatility in the stock / index and the
prices moving significantly in either direction. Since OTM options are
purchased for both Calls and Puts it makes the cost of executing a Strangle
cheaper as compared to a Straddle, where generally ATM strikes are purchased.
Since the initial cost of a Strangle is cheaper than a Straddle, the returns
could potentially be higher. However, for a Strangle to make money, it would
require greater movement on the upside or downside for the stock / index than
it would for a Straddle. As with a Straddle, the strategy has a limited
downside (i.e. the Call and the Put premium) and unlimited upside potential.
When to Use: The investor thinks that the underlying
stock / index will experience very high levels of volatility in
the near term.
Risk: Limited
to the initial premium paid
Reward:
Unlimited
Breakeven:
·
Upper
Breakeven Point = Strike Price of Long Call + Net Premium Paid
·
Lower
Breakeven Point = Strike Price of Long Put - Net Premium Paid
Example
Suppose Nifty is at 4500 in May. An investor, Mr.
A, executes a Long Strangle by buying a Rs. 4300 Nifty Put for a premium of Rs.
23 and a Rs 4700 Nifty Call for Rs 43. The net debit taken to enter the trade
is Rs. 66, which is also his maxi mum possible loss.
Strategy
: Buy OTM Put + Buy OTM Call
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Nifty index
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Current Value
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4500
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Buy Call Option
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Strike Price (Rs.)
|
4700
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Mr. A pays
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Premium (Rs.)
|
43
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Break Even Point (Rs.)
|
4766
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Buy Put Option
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Strike Price (Rs.)
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4300
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Mr. A pays
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Premium (Rs.)
|
23
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Break Even Point (Rs.)
|
4234
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The
payoff schedule|
On expiry
|
Net Payoff from Put
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Net Payoff from Call
|
Net Payoff
|
|
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Nifty closes at
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purchased (Rs.)
|
purchased (Rs.)
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(Rs.)
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3800
|
477
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-43
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434
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|||
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3900
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377
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-43
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334
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|||
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4000
|
277
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-43
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234
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|||
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4100
|
177
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-43
|
134
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|||
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4200
|
77
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-43
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34
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|||
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4234
|
43
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-43
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0
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4300
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-23
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-43
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-66
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4400
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-23
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-43
|
-66
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4500
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-23
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-43
|
-66
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4600
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-23
|
-43
|
-66
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4700
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-23
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-43
|
-66
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4766
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-23
|
23
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0
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4800
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-23
|
57
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34
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4900
|
-23
|
157
|
134
|
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|||
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5000
|
-23
|
257
|
234
|
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|
5100
|
-23
|
357
|
334
|
|
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|||
|
5200
|
-23
|
457
|
434
|
|
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|||
|
5300
|
-23
|
557
|
534
|
|
The
payoff chart (Long Strangle)
+ =
Buy OTM Put Buy OTM Call Long Strangle
