Long Strangle
Risk: medium
Reward: very high
General Description
Entering a long strangle entails buying out-of-the-money calls and puts.
The Thinking
You are not bullish or bearish but you do think a big move is coming soon. If the stock rallies huge, the puts will expire worthless, and you could profit from the calls. If the stock drops, the opposite will be true. But you need a big move; if the underlying stock just sits there, both the calls and puts will rapidly deteriorate in value.
Example
Let's say PG is trading @ 65 and you think a big move is coming. You buy the 70 calls for 3.9 and the 60 puts puts for 4.1 for a total debit of 8.0. If the stock rallies above above 78, the puts will expire worthless, but your calls will more than make up for it, and you'll profit on the entire trade. If the stock drops below 52, the calls will expire worthless, but your puts will more than make up for it, and you'll turn a profit. So, like the long straddle, you must get a big move in one direction or the other or else your calls and puts will deteriorate in value and you'll incur a loss on the trade..
The image below summarizes the trade with a P/L Diagram. |
