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Multi-leg Strategies

Long Strangle

A long strangle involves buying a call and a put option with the same expiration date but different strike prices. The call’s strike price is always higher than the put’s strike price. Investors may use a long strangle when they expect significant price volatility in the underlying asset but are uncertain about the direction of the movement.
  1. Outlook: Volatile
  2. Use: Primarily used to profit from big changes in the underlying stock price, whether up or down. It’s often used when there is an event on the horizon that could either be very good or bad for the stock, like an earnings call or product launch
  3. Profit: You’ll profit if the stock price rises above (call strike price + premium paid) or falls below (put strike price - premium paid) the breakeven prices
  4. Loss: You’ll incur losses if the stock price does not move much, remaining between the breakeven prices

Risks

While strangles can be less expensive to implement than straddles, they often require even greater movement in the underlying stock price to become profitable given the different strike prices of the call and put options.

Basic example

Let’s say that you believe there will be significant price movement for FlyFit when they release their quarterly earnings. FlyFit is trading at $100 so you purchase a call option with a $106 strike price for a $4 premium, and you also purchase a put option with a $94 strike price for a $4 premium.
  1. Strike price: $106 Call, $94 Put
    Strike price represents the price you’d pay if you were to exercise your call or the price you’d receive if you were to exercise your put
  2. Contract price: $4 Call, $4 Put
    Per-share price of the option contracts
  3. Total cost: $800
    Options have a contract multiplier, or the number of shares presented. Total cost is the contract premium x the contract multiplier for all options, or $4 x 100 for both the call and put. There may be additional fees charged by your Brokerage.
If you exercise the call option, you’d purchase 100 shares for a total of $10,600. If you exercise the put option, you’d deliver 100 shares and receive $9,400.

Maximum profit and loss

The P/L calculations take into consideration both the long call and long put positions.
  1. Max loss: $800
    The maximum loss of a long strangle is the premium you paid for the call and put options if both options expire worthless
  2. Breakeven: $114 and $86
    There are two breakeven prices, calculated as the strike price +/- total premium paid
  3. Max profit: Unlimited
    Difference between FlyFit’s current price and the breakeven x the contract multiplier (usually 100)
The max profit can be unlimited — the call option value increases along with the stock price and the put option value increases as the stock declines. Max profit occurs when the stock price is $0 or infinite.

Profit if...

FlyFit’s stock price is above the higher breakeven price (call) or below the lower breakeven price (put).
  1. Total profit: ($120 - $106 - $8) x 100 = $600
    Difference between the current price and strike price, less the cost of the put and call options
In the scenario above, you’d purchase 100 shares of FlyFit for $106, or $10,600. You would immediately sell your shares for the market price of $120, or $12,000 total. This results in a gain of $1,400, but since the options originally cost $800, the overall trade results in a net profit of $600.

When FlyFit's stock price rises well above the call’s strike price, exercising the call option and selling the underlying shares at the prevailing price more than compensates for the cost of both options. Similarly, if the price falls well below the put’s strike price, the put option will be in-the-money and could lead to a profitable trade.

In either scenario, one of the options expires worthless, but the other option’s profits exceeds the cost of entering into the long strangle.

Loss if...

FlyFit’s stock price remains relatively stable and does not go above or below a certain price.
  1. Total loss: ($110 - $106 - $8) x 100 = $400
    Difference between the current price and strike price, less the cost of the put and call options
In the scenario above, you’d purchase 100 shares of FlyFit for $106, or $10,600. You would immediately sell for the market price of $110, or $11,000. This results in a gain of $400, but since the put option and call option originally cost $800, the overall trade results in a net loss of $400.
The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.

Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.

Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).

Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.

Options resource center

Options Foundations
Fundamentals
Multi-leg Strategies
long-straddleChapter 14Long straddle
long-strangleChapter 15Long strangle
debit-spreadChapter 16Debit spread
credit-spreadChapter 17Credit spread
calendar-spreadChapter 18Calendar spread
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