how a strangle option works:

 

A strangle is an options trading strategy that involves buying both a call option and a put option with the same expiration date but different strike prices. This strategy is used when an investor expects a significant price movement in the underlying asset, but is uncertain about the direction of the move.

Here's how a strangle option works:

Selecting the Options: To implement a strangle, you choose an out-of-the-money call option and an out-of-the-money put option. An out-of-the-money option means the strike price is above the current market price for a call option or below the current market price for a put option. The distance between the strike prices of the call and put options should be relatively equal.

Buying Call Option: The call option gives you the right, but not the obligation, to buy the underlying asset at the specified strike price before the expiration date. By purchasing a call option, you are betting that the underlying asset's price will increase significantly.

Buying Put Option: The put option gives you the right, but not the obligation, to sell the underlying asset at the specified strike price before the expiration date. By purchasing a put option, you are betting that the underlying asset's price will decrease significantly.

Profit Potential: The strangle strategy aims to profit from a significant price movement in either direction. If the price of the underlying asset moves significantly above the call option's strike price, the call option can generate a profit. Conversely, if the price moves significantly below the put option's strike price, the put option can generate a profit. The potential profit is theoretically unlimited on either side.

Risk and Breakeven Points: The risk in a strangle strategy is the premium paid for both the call and put options. If the price of the underlying asset remains between the strike prices of the options at expiration, both options may expire worthless, resulting in a loss of the premiums paid. The breakeven points are calculated by adding or subtracting the premiums paid from the strike prices.

Time Decay: It's important to consider the impact of time decay, also known as theta, on the strangle strategy. As time passes, the value of both the call and put options may decrease due to the diminishing time remaining until expiration. Therefore, it's crucial to have a significant price movement within a reasonably short time frame for the strategy to be profitable.

Managing the Trade: Traders may choose to close the position before expiration if they achieve their desired profit or if the market conditions change. Alternatively, they can hold the position until expiration and exercise the options if they are in the money or allow them to expire if they are out of the money.

It's important to note that options trading involves risks, including the potential loss of the entire premium paid. Options strategies like the strangle can be more complex and suitable for experienced traders who understand the associated risks and have a clear view of the potential price movement in the underlying asset. It's advisable to consult with a financial advisor or options trading specialist before engaging in options trading strategies.