In this post, we will learn about how and when to use strangle.
Strangle is an options strategy where we buy 2 options (1PE & 1 CE) of the different strike price of the same maturity on the same stock.
When to use Strangle option strategy?
Strangle option strategy is used when we expect the high volatility of the stock/index is going to increase in future.
The volatility of stock/index is the fluctuation or degree of movement in prices with respect to time. Volatility generally increases when some event or news going to occur.
There could be various events in the company which could increase the volatility of the stock such as Fundraising from QIP or change of management etc.
How to use Volatility to make profitable trade?
As said earlier we can use strangles option strategy when we expect volatility to increase in future.
Let us learn this strategy from a simple example of Reliance
Reliance is trading around Rs 1509.6. In the strangle strategy we buy 1 Put (Lower strike price) and 1 Call (Higher strike price) of the different strike price on the same stock. Suppose we buy 1450PE & 1540CE of reliance, which will cost us
(22.30+32.55) = 54.85 (Net premium paid)
When volatility of Reliance will increase in future net premium will increase, which is the place we make a profit.
Note: It is very much necessary to buy and exit both options simultaneously.
What Strike Price should you select?
Option premium for call options tends to decrease as we go away from the stock price and the completely opposite is applicable for put options.
Your options strick price should be the same points away from the stock price. This is done to capture the equally likelihood of both side movement in the stock price.
PE: 1509.4-1480= 29.4
CE: 1540-1509.4=30.6
And you need to select a strike price according to your risk capacity. If you select deep out of the money option they might not increase much on a high volatile event.
Hence, you need to trade between your risk-taking capacity and the reward you want to earn.
Example of Strangle on YesBank
We were expecting high volatility on yesbank stock due to upcoming quarterly results. We deployed strangle (bought 70CE & 45PE) in morning and results were expected after market hours.
Net Premium: 3.3+4.9 =8.2
As expected there came some news regarding capital infusion hours before the results and stock surged 22% in just few minutes.
Net Premium: 1.7+10.85 = 12.55
Just after a few more mins stock surged to 32%.
Net Premium: 1.5+14.10= 15.6
This is a very good example where strangle delivered a very handsome profit in a short period of time.
