| Risk: |
Limited |
| Reward: |
Unlimited |
| The Trade: |
Buying out-of-the-money calls and puts |
ABC Stock trading at £5.00
Buy 1 Sep £6.00 call and buy 1 Sep £4.00 put (see pay-off diagram below)
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| When to use: |
You believe a stock will have an explosive move either up or down. This strategy is similar to a Straddle but the premium paid is less, but a larger move is needed to show a profit. |
| Volatility expectation: |
Very bullish, increases in volatility work marvels for the position. |
| Profit: |
The profit potential is unlimited although a substantial directional movement is necessary to yield a profit. |
| Loss: |
Limited to the premium paid in establishing the position. |
| Breakeven: |
Occurs if the market rises above the higher strike price at B by an amount equal to the cost of establishing the position, or if the market falls below the lower strike price at A by the amount equal to the cost of establishing the position. |
| Time decay: |
This position is a major wasting asset. As time passes the value of position erodes. If volatility increases, erosion slows, if volatility decreases, erosion speeds up. |
| Long Strangle trading ideas and tactics: |
- Can mix the strikes up depending on whether you lean towards the bull or bear tract but are still overall neutral - Perhaps you feel the odds slightly favour a bull move. If stock is at £5.00 instead of buying the £4.50P and £5.50C you could buy the £4.50P and £6.00 call
- Use some sort of time stop because time erosion is your enemy, ie if the market hasn’t made a big move within 2 weeks consider dumping the trade
- If you expect a mega move then this is a better strategy than Straddles because Strangles are cheaper to buy. more can therefore be bought with the same amount of capital
- Look to trade when the markets have been quiet for a long time and volatility is low, if this is the case look to trade the longer dated months
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