Options straddles and strangles are a way for advanced traders to get long or short exposure to volatility (vega), but the volatility needs to be weighted against time decay (theta). Here are the basics.
Traders new to options strategies typically begin with the basic call and put strategies—selling covered calls for potential income and buying puts for temporary downside protection. Although many traders never venture beyond the basics, some look at the versatility and flexibility of advanced options strategies and move to strategies that can help them with pinpointed objectives.
When traders first consider moving into more advanced strategies, the first thing they think of is greater risk potential. That’s important, but also consider that advanced strategies are more complex, so understanding what your trades will be doing under different conditions becomes even more important.
Case in point: options straddles and strangles. These spread combinations are for the option trader who’s expecting a rise in implied volatility (IV) or a rise in price volatility to move significantly in one direction or the other, but isn’t certain which way.
For example, perhaps there’s an earnings report coming up on a stock you’re considering. Or maybe there’s a product launch on tap and you think it’s either going to be revolutionary … or a colossal flop. But one way or the other you believe price volatility could be on the way.
These two strategies—straddles and strangles—could help you get that price volatility (vol) exposure. A straddle options strategy involves buying a call and a put of the same strike and same expiration date, whereas a strangle involves buying an out-of-the-money (OTM) call and put of the same expiration date but different strikes.
Straddle and strangle options strategies are considered “directionally agnostic,” meaning it’s about the magnitude of a move, not the direction. When you buy an at-the-money (ATM) straddle, it has a net delta of close to zero because the delta of the call is offset by the delta of the put. So a significant move up in the price of the underlying should have roughly the same effect on the theoretical value of the straddle as an equivalent down move in the price of the underlying.
The same can be said for the purchase of a strangle made up of equivalent-delta options (such as a .20 delta call and a -.20 delta put). Up or down, a big move is a big move. (And for more on delta and other “options greeks,” have a look at this primer.)
You might think, “If the stock price goes up, my call goes up in price, but the put loses value.” True. But that’s where magnitude comes in. As a stock price continues in one direction, the in-the-money options leg should keep rising in value—eventually moving one-to-one with the underlying, unless implied volatility moves down at the same time price is moving strongwhile the OTM leg approaches zero but can go no lower. To illustrate, look at the straddle and strangle profit and loss (P&L) graphs in figure 1.
So, which should you choose, the straddle or the strangle? The answer, as is often the case with options strategies, is that it depends on your objectives and risk tolerance. In general, a long straddle will cost more, but its theoretical value begins rising as soon as you move away from the strike price. Conversely, the strangle is generally less expensive to buy, as its legs consist of OTM options, but the strangle doesn’t pick up steam until the underlying gets close to one of the two strikes.
Let’s look at an example.
Using the 70-strike options prices in table 1, you could buy the straddle for $2.80 ($1.40 for the call and $1.40 for the put), plus transaction costs. At expiration, if the stock is either higher or lower than $70 by more than $2.80, then the straddle would in theory be a winner. A strangle example could be the 68 put and the 72 call. Buying the strangle would cost $1.40—half of what the straddle cost (again, plus transaction costs). With this lower cost, though, comes the need for the stock to move more to make the strangle profitable. At expiration, not including transaction costs, the stock would need to be below $66.60 ($68 – $1.40) or higher than $73.40 ($72 + $1.40). This example does not take volatility into consideration. Read on to see how IV can impact a straddle and strangle.
| Stock Price = $70 | Call Bid | Call Ask | Strike | Put Bid | Put Ask |
| 25 days till expiration | 2.65 | 2.80 | 68 | 0.65 | 0.75 |
| 2.05 | 2.15 | 69 | 1.05 | 1.10 | |
| 1.35 | 1.40 | 70 | 1.35 | 1.40 | |
| 0.90 | 0.95 | 71 | 1.85 | 2.00 | |
| 0.60 | 0.65 | 72 | 2.50 | 2.70 |
Options typically don’t need to be held through expiration. Many traders will look to close their straddle or strangle once the date of the anticipated move has passed. By owning a straddle or strangle, you have two options, both subject to time decay (“theta”), the natural daily erosion of options prices.
One risk of buying a straddle or strangle is that the magnitude of price movement in the underlying stock may not be enough to compensate for the theta. The higher the IV as you enter the trade, the higher the entry price point for your straddle or strangle, and thus the greater the price move you may need to see in the underlying before you’re able to break even.
How can you determine whether a stock’s IV is high or low? One way is to use the IV percentile, available on the thinkorswim® platform under the Trade tab > Today’s Options Statistics. The IV percentile indicator compares the current IV to its 52-week high and low values. The larger the IV percentile, the higher the current IV relative to values over the last year. However, a high IV doesn’t necessarily mean it’s too high to consider. Nor is it a slam dunk to get long vol exposure just because it may look cheap. Sometimes a price is relatively low or high for a reason.
Holding on to a straddle or strangle through earnings (or other widely anticipated events) can be a double-edged sword. Sure, you’re looking to capitalize on the big move, but typically once the news is out and the stock has its move one way or the other, vol tends to get hit. So as you’re weighing the risks, be sure to understand the price dynamics. In options parlance, it’s about weighing the positive gamma against the effects of theta and vega. See figure 2.
Long options straddles and strangles can be used to target directionally agnostic movement. But it’s not enough to simply have the underlying stock move; the movement has to be enough to overcome options decay, the potential of which is reflected in the options price at time of entry. However, given sufficient magnitude, long straddles and strangles options strategies can become profitable irrespective of direction.
Of course, the opposite is also true. Think vol is too high and poised to come down? Or think the underlying is liable to sit still for a while and you’d like that theta to act as a tailwind instead of a headwind? Flip those charts in figure 1 upside down and they’re what a short straddle and strangle look like. But notice that, with the long strategies, the profit potential is open-ended. With the short strategies—yep, you guessed it—the risk is open-ended.
Some traders who play events from the short side choose to limit risk to the upside and downside by buying a strangle that’s further OTM than the strikes in a short straddle or strangle. These four-legged spreads also have names. A long strangle OTM against a closer-to-ATM short strangle is called an iron condor. A long strangle against a short straddle is called an iron butterfly. But one thing to remember: The more legs you add to a spread, the higher your transaction costs will be. Also, don’t forget the additional complexity of a four-leg strategy.
There’s no right or wrong way to play single events such as earnings reports. A lot depends on your market views, your objectives, and your risk tolerance. Options straddles and strangles can be an effective way to trade volatility, but make sure you know and are comfortable with the risks involved.