Strangle vs Straddle: Which Options Trading Strategy is Better

Straddles vs. Strangles: Key Differences Explained

If you’re familiar with the concept of a straddle, understanding a strangle will be a breeze. Both strategies are based on similar principles, with the strangle being an evolution of the straddle designed to lower implementation costs. Let me break it down for you.

Imagine Nifty is trading at 5921, making 5900 the ATM strike price. To execute a Long Straddle, you would buy both a 5900 CE and 5900 PE, with their respective premiums at 66 and 57. 

Total premium = 66 + 57 = 123 

Upper breakeven = 5921 + 123 = 6044 

Lower breakeven = 5921 – 123 = 5798 

Basically, a straddle allows you to spend 123 to create a market-neutral position, which remains unaffected by directional shifts. This strategy is effective when you expect significant price changes but are unsure about the direction.

So, you’ve now created a straddle that requires an upfront cost of 123. It’s a powerful tool to profit from market fluctuations regardless of the trend.

But what if you could achieve a similar market-neutral setup with lower costs?

That’s where the ‘Strangle’ comes in.

Setting Up a Strangle: Key Steps

A strangle is a variation of the straddle that reduces the strategy’s cost but increases the breakeven points. 

While a straddle involves buying both ATM call and put options, a strangle uses OTM call and put options, which are less expensive. This makes a strangle a more cost-effective strategy.

For example, if Nifty is trading at 7921, to set up a Strangle, you would buy both OTM Call and Put options with the same expiration date and asset. For this example, you might select the 7700 Put and 8100 Call options, priced at 28 and 32 respectively.

Let’s review the P&L in different market scenarios. I’m sure you can now estimate the outcome in various conditions, but here’s a quick summary.

Profit and Loss Scenarios for a Strangle

1. Market at 7500 (below the PE strike):

• The call option expires worthless.
• The put option gains 200 points in intrinsic value.
• After subtracting the premium (28), total profit from the put option is 172. Deducting the 32 premium for the call, the net profit is 140.

2. Market at 7640 (lower breakeven):

• The 7700 put option has a value of 60, equal to the combined premium of 60, resulting in no profit or loss.

3. Market at 7700 (at the PE strike):

• Both options expire worthless, and the total premium (60) is the maximum loss.

4. Market at 7900 or 8100 (near the strikes):

Both options expire worthless, resulting in a total loss of 60.

5. Market at 8160 (upper breakeven):

The 8100 call option gains 60 points, covering the premium cost.

6. Market at 8300 (above the CE strike):

The 8100 call option’s value increases by 200 points, leading to a net profit of 140 after deducting the premium.

Key Takeaways:

• The maximum loss is capped at the net premium paid.
• Losses are highest between the two strike prices.
• Upper breakeven = CE strike + net premium paid.
• Lower breakeven = PE strike – net premium paid.
• Profit potential is unlimited as long as the market moves.

Common Pitfalls in Strangle vs. Straddle Strategies

When using these options strategies, traders often make several mistakes that can limit their success:

• Ignoring Market Conditions: Straddles work best in high volatility, while strangles perform better in moderate volatility. Align your strategy with the market.
• Miscalculating Breakeven Points: It’s crucial to accurately calculate break-even levels for both strategies, factoring in the total premiums paid.
• Overcommitting to One Strategy: Be flexible and ready to switch if market conditions change.
• Neglecting Position Sizing: Manage risk by sizing positions appropriately.
• Failing to Monitor Positions: Regularly check market movements and adjust your strategy as needed.
• Forgetting Transaction Costs: Always account for fees and commissions, as they can eat into profits.
• Ignoring Exit Strategies: Plan when to exit to avoid emotional decision-making.

By understanding these pitfalls, you can better navigate the complexities of options trading and increase your chances of success. Careful planning and analysis are essential to effectively managing risks and maximizing profits.