Home > Forex practice > Risk management > Option: straddle and strangle

Business tactics for you; straddle & strangle

Any business, market or investment needs successful tactics to implement and come through. The forex also is also not different from any other. There are many tactics and techniques which can and are being used to reduce ones losses, increase the profit margin and become a much better trader at the same time.

Two of the most commonly used techniques common to both the stock and forex market are straddle and strangle. We will go through both of them trying to see their utility and in which situation they can be applied.

Straddle

Many of the terms used are borrowed from the farming community and straddle is no different. Straddle is the option where the investors gives a buy and sell option for the same strike price. In simple terms, if the strike price of an option is 40$, the investor puts a sell and buy option at 40$. The above option may sound very ludicrous and sometimes it is, but if the stock moves significantly it's a great decision.

Straddling an option is great if significant drop or raise is expected or predicted. If the movement is very small, the investor would have made a bad call and significant losses.

For example, for an option of a company ABC, the price is 55$ and suppose that company is nominated for a very prestigious award. If they win it the price will shoot up sky high and if they loose it, the price will go down. Now, if a trader decides to buy 55$ a call and 55$ a put on ABC, 55$ being the closest strike price to 53$, the total opening investment adds up to 3.75$. After the awards night, say if they win the award and the price goes up to $62 and the trader closes the both deals. He would make profit of %4.50 with investment of %3.75.

Strangle

This is also another very interesting tactic, which is somewhat different from straddle. In this the investor option puts a call option at much lower rate than the strike price and a put option at a much higher rate than the trading strike price of the option. For this method to succeed also a large movement is required in either the up or the down option.

Let's take a hypothetical example. Suppose the strike price of an option is 50$. For the strangle method to work, a call option is put at say 35$ and a put option at 65$. Now suppose there is a massive movement in either direction, the investor is at a profit. If it remains in the call and put bracket he has set, the investor makes a loss.

Conclusion

So, the straddle and strangle options are good only if a massive movement is expected in either direction. If only there is a small movement, it results in a loss for the investor. Generally the above 2 tactics are practiced only when a sudden increase or decrease is expected. Else it is always safer to stick with the market trends and trust your instincts.