Strangle Explained: A Low Risk Options Strategy to Profit in Either Direction

What is a Strangle Option Strategy?

A strangle is a sophisticated bidirectional options strategy that involves the simultaneous purchase of both call and put options for the same underlying asset. These options share the same expiration date but feature different strike prices. The fundamental principle behind this strategy is that since both calls and puts are involved, the strangle option strategy will benefit the trader as long as there's a significant enough movement in the asset's price, regardless of the direction.

This approach is particularly valuable in the cryptocurrency market, where price volatility is a defining characteristic. By holding both call and put positions, traders position themselves to profit from substantial price movements without needing to predict the exact direction of the move. The strategy essentially allows traders to capitalize on market uncertainty and volatility, making it an essential tool in the crypto options trading toolkit.

Why are Strangle Options So Popular Among Traders?

A key characteristic of strangles is their unique ability to cover both directional scenarios — regardless of whether the digital asset's price appreciates or depreciates. This versatility ultimately makes the strangle option strategy a favorite among crypto options traders who keep abreast of the latest market happenings and are aware that prices are about to get volatile.

The popularity of this strategy stems from its practical application in uncertain market conditions. When traders expect a large price movement for the underlying cryptocurrency but aren't sure whether it'll be higher or lower, they can choose to play both fields by buying or selling both calls and puts. This allows undecided crypto options traders to make money on either side of the forecasted move while limiting their overall risk exposure.

Furthermore, the strangle strategy is particularly effective during periods of anticipated market catalysts, such as major protocol upgrades, regulatory announcements, or significant macroeconomic events. In these scenarios, traders can position themselves to profit from the expected volatility without taking a definitive stance on market direction, thereby reducing the psychological pressure of making a binary directional bet.

Understanding Implied Volatility

Before further exploring the benefits and risks of trading strangle options, it's essential to first understand that strangles are volatility-based options strategies. In other words, they only thrive during instances of high implied volatility (IV). As a determining factor that accounts for the amount of uncertainty within the market, IV measures the expected price movements in an options contract.

Each contract has its own unique IV, which fluctuates over the lifespan of the option and is largely determined by the trading activity of crypto options buyers and sellers. Understanding how IV works is crucial because it directly impacts the premium you'll pay for options contracts. Higher IV typically means higher premiums, as the market is pricing in greater uncertainty and potential for significant price movements.

For reference, the IV of an options contract tends to be higher right before an upcoming catalyst is about to happen. This could range from a major blockchain network upgrade to a huge macroeconomic announcement regarding inflation from central banking authorities. The anticipation of these events creates uncertainty in the market, which is reflected in elevated IV levels.

Given that strangles are closely tied to volatility, it's crucial for crypto options traders to first understand IV before diving headfirst into executing strangle options strategies. Successful strangle traders often monitor IV trends and look for opportunities where they believe the market is underpricing or overpricing expected volatility, allowing them to enter positions with favorable risk-reward profiles.

Perks of Trading Strangle Options

Minimizing Exposure to Directional Risk

The most significant advantage of using a strangle options trading strategy is the fact that it allows you to make gains regardless of whether the crypto asset's price goes up or down — the move just has to be significant. This can be extremely helpful if you're still in a dilemma about your directional bias after conducting the necessary due diligence and market research and want to protect yourself against directional risk.

This characteristic makes strangles particularly valuable in the cryptocurrency market, where predicting short-term price direction can be challenging even for experienced analysts. By removing the need to be correct about direction, traders can focus instead on assessing whether a significant move is likely to occur, which can often be easier to determine based on upcoming events or market conditions.

Low Capital Intensity

Another benefit is that strangle options are significantly more affordable than most crypto options strategies. This is because out-of-the-money (OTM) options contracts tend to have lower premiums than their in-the-money (ITM) counterparts due to their lack of intrinsic value. This cost efficiency allows veteran strangle options traders to leverage themselves sufficiently to make their measured speculative trade.

The lower capital requirement also means that traders can potentially deploy multiple strangle positions across different assets or expiration dates, diversifying their volatility exposure. This flexibility in position sizing and portfolio construction makes strangles accessible to traders with varying capital levels, from retail participants to institutional players.

Risks of Trading Strangle Options

Highly Dependent on Volatility and Catalysts

Since strangles involve OTM calls and puts, they're less likely to provide gains since the options strategy will require a huge movement in either direction for options traders to even come close to breaking even. That's why crypto traders who execute strangles must have advanced knowledge about market timing to take advantage of an upcoming catalyst or major news event.

The success of a strangle strategy is heavily dependent on the trader's ability to identify periods of underpriced volatility or upcoming catalysts that will drive significant price movements. Without these conditions, the strategy can result in complete loss of the premiums paid, as both options may expire worthless if the underlying asset's price remains relatively stable.

Additionally, traders must be aware of the risk of volatility crush, which occurs when IV drops sharply after an anticipated event passes. This can cause the value of both options to decline rapidly, even if the underlying asset has moved, potentially resulting in losses despite being directionally correct about the price movement.

Not a Beginner-Friendly Options Strategy

Unlike other options strategies that involve trading options with some form of intrinsic value, strangles deal exclusively with OTM options. This means they're highly prone to theta decay over time. That's why beginner options traders could lose almost all of their premiums overnight if they aren't careful when it comes to deciding the right strike prices and expiry dates.

The complexity of managing theta decay, combined with the need to understand implied volatility dynamics and market catalysts, makes strangles a strategy best suited for experienced traders. Beginners should first gain proficiency with simpler options strategies and develop a solid understanding of options Greeks before attempting to trade strangles in live market conditions.

Types of Strangle Options

There are two types of strangle strategies in options trading:

• Long strangles which involve buying a call and a put at OTM strike prices
• Short strangles which involve selling a call and a put at OTM strike prices

Long strangles are the more popular strategy of the two as they typically involve less risk and defined maximum loss. Let's first go through how long strangles work before explaining the mechanics of short strangles. For both of the examples below, we'll be referring to hypothetical BTC prices of approximately $34,000 and for the call and put contracts to have expiry dates in late November as illustrative examples.

Understanding the distinction between these two approaches is crucial, as they represent fundamentally different market outlooks and risk profiles. Long strangles are appropriate when expecting increased volatility, while short strangles are used when expecting decreased volatility or range-bound price action.

Long Strangle Example

To execute a long strangle, a trader must purchase a call and a put option at the same time. Both would be OTM, while the call's strike price would be higher than the cryptocurrency's current market price. The put's strike price would, as expected, be lower than the coin or token's current market price. The premium paid for both contracts represents the trade's maximum risk and defined loss potential.

With this set-up, the upside-profit potential is theoretically unlimited if the cryptocurrency experiences an upward surge in price. However, significant profit potential also exists if the coin or token's price falls substantially. The key is that the price movement must be large enough to overcome the combined premiums paid for both options.

For our long strangle example, assuming BTC trades at approximately $34,000, if we're expecting a huge move in Bitcoin's price in either direction related to a major market catalyst, crypto option traders could purchase both the $30,000 BTC put and $37,000 BTC call. This will account for approximately a 10% swing in either direction and will cost around $1,320 in total premiums as a hypothetical example.

By executing this long strangle option strategy, crypto options traders are hoping that a significant market catalyst will cause a spike in BTC prices and cause their OTM options to become ITM thanks to substantial price fluctuations. The breakeven points for this trade would be $28,680 on the downside ($30,000 - $1,320) and $38,320 on the upside ($37,000 + $1,320), meaning Bitcoin would need to move beyond these levels for the trade to become profitable.

Short Strangle Example

Similarly, a crypto trader looking to execute a short strangle would sell puts and calls at the same time, both of which are OTM. Unlike a long strangle, however, is the reduced potential for profit — requiring the cryptocurrency to trade in a relatively tight range, as the maximum earnings are equal to the premium collected from the contracts' buyer.

This strategy is essentially the opposite of a long strangle and is used when a trader expects low volatility or range-bound price action. The trader profits if the underlying asset's price remains between the two strike prices until expiration, allowing both options to expire worthless and the trader to keep the entire premium collected.

For the short strangle example, assuming BTC is currently at approximately $34,000, if we believe that BTC prices will remain relatively stable through late November, it would make sense to execute a short strangle instead. In scenarios where major market catalysts are delayed or market conditions favor consolidation, this could ultimately cause BTC prices to trade in a range until further developments occur.

To make a play off this lack of volatility, crypto options traders could follow suit with the example above and write both the $37,000 BTC call and $30,000 BTC put contracts to collect approximately $1,320 in credited option premiums. Similarly, this also accounts for approximately a 10% buffer from the current $34,000 price of BTC.

In writing these contracts and performing a short strangle options strategy, crypto options traders are risking potentially unlimited losses should Bitcoin rally significantly and exceed the intended range of prices. That's where it's necessary for these crypto traders to perform their required due diligence in deciding whether it's worth it from a risk-reward analysis to collect $1,320 in premiums while facing the risk of substantial losses if the market moves dramatically.

Short strangles require active risk management and often benefit from the use of stop-loss orders or adjustment strategies to limit potential losses if the market moves against the position.

Strangle vs. Straddle — Which is the Better Option Strategy?

Both strangles and straddles are options strategies that allow crypto traders undecided on the direction of a cryptocurrency's next move to make gains on a large swing in either direction. However, a key difference lies in how each strategy is executed and the risk-reward profile they present. While the strike prices of call and put contracts of strangle options strategies are OTM and different, straddles feature call and put contracts with the same strike price, typically at-the-money.

As straddle options strategies involve purchasing at-the-money calls and puts, they typically cost more to execute than strangles. This higher cost reflects the fact that at-the-money options have greater intrinsic value and are more likely to become profitable with smaller price movements. Additionally, when comparing strangles with straddles, it's often noted how straddle options strategies carry less risk of total loss than their strangle counterparts since they require a smaller price move to achieve profitability.

The choice between these strategies often depends on the trader's view of how large the expected move will be. If a trader expects a massive move, strangles offer better leverage due to their lower cost. If the expected move is more moderate, straddles may be more appropriate due to their lower breakeven points.

Ultimately, it comes down to personal preference, capital availability, and market outlook. If you're limited on capital and have a higher risk tolerance with expectations of very large price movements, strangles are the ideal options strategy. Conversely, straddles have increased chances of profitability with moderate moves and work as an effective lower-risk options strategy for traders with more capital to deploy.

Final Words and Next Steps

Where there's volatility, there'll likely be profitable trading opportunities to be captured. That's where volatility-based options strategies like strangles come into play and have become so popular among crypto options traders. Whether you're someone who rides the wave of volatility through long strangles or writes the contracts for said wave riders through short strangles, it's best to first understand the benefits and risks of strangles before executing them in live market conditions.

From exploring volatility as a concept and understanding implied volatility dynamics to highlighting specific use cases of long and short strangles with practical examples, we hope our comprehensive guide to strangle options has helped in adding another valuable tool to your crypto options strategy arsenal. As with any trading strategy, proper risk management, position sizing, and continuous education are essential for long-term success in options trading.

Before implementing strangle strategies with real capital, consider practicing with paper trading or small position sizes to gain familiarity with how these strategies perform under various market conditions. Understanding the interplay between implied volatility, time decay, and price movement is crucial for mastering this versatile options strategy.

FAQ

What is a Strangle options strategy and how does it help investors profit in either direction?

A Strangle strategy involves simultaneously buying a call and put option at different strike prices. It enables investors to profit from significant market volatility regardless of direction, requiring lower initial capital investment compared to other strategies.

How to establish a strangle position? Which option contracts need to be bought or sold?

To establish a strangle position, buy one out-of-the-money (OTM) call option and one OTM put option with the same expiration date. This strategy profits from significant price movements in either direction while requiring lower premium costs than a straddle.

What are the risks of the Strangle strategy? How are maximum loss and maximum profit calculated?

Maximum loss is unlimited as underlying price can rise infinitely. Maximum profit is fixed, calculated as the difference between strike prices minus total premiums paid. Risk occurs if price stays between strikes at expiration.

What is the difference between Strangle and Straddle strategies? Which one is more suitable for me?

Strangle requires larger price moves and lower costs, ideal for high volatility expectations. Straddle uses at-the-money strikes, better for moderate volatility. Choose Strangle for extreme moves, Straddle for balanced exposure. Your choice depends on volatility outlook and risk tolerance.

When should you use the Strangle strategy in market conditions?

Use Strangle when anticipating high volatility but uncertain price direction. This strategy profits from significant price movements in either direction without needing to predict the specific trend.

How to choose appropriate strike prices to create an effective strangle?

Select out-of-the-money call and put options with identical expiration dates but different strike prices. Choose strikes based on expected volatility range and profit targets to maximize gains from significant price movements in either direction.

What are the breakeven points for a Strangle strategy and how to determine them?

Upper breakeven point: Call strike price plus total premium paid. Lower breakeven point: Put strike price minus total premium paid. Profit occurs when price moves beyond these points at expiration.

What is the difference between Long Strangle and Short Strangle? When should each be used?

Long Strangle buys both out-of-the-money call and put options, profiting from large price moves in either direction. Short Strangle sells both options, profiting when price stays between strikes in neutral markets.