What is a long strangle?
A long strangle profits when the price of the underlying security moves a lot in either direction. The strategy is made up of a call option and a put option whose strike prices are "out-of-the-money", meaning they sit outside the current market price of the underlying stock. The expiration dates of the options will also be the same. Buying these two options together will define the maximum risk for the trade.
A long strangle has a limited amount of time in which it can be profitable. If the underlying stock does not move far or fast enough, or volatility decreases, the long strangle will lose money quickly and result in a loss.
When to use a long strangle strategy
A long strangle position is entered when traders expect volatility to increase in an underlying stock. Note that long strangles and long straddles are similar in that they both rely on large directional moves and increased volatility. A long strangle costs less money to enter but it needs a larger move in stock price or volatility to make a profit because the strike prices are farther away from the underlying stock’s current price.
How to manage a long strangle position
A long strangle strategy is more vulnerable to time decay than other strategies. This is because you are holding two options long. So as time advances, the time value of both options decreases simultaneously.
If you want your long strangle to work well, you need implied volatility to increase. When this happens, it makes the value of both options rise. It also means that there is a greater chance that the underlying stock's price will go up substantially. If the implied volatility decreases, it will naturally have a negative effect on the value of both of the options you are holding.
Long strangles can be adjusted like most options strategies, but it will usually come at a higher cost and add a debit to the trade that pushes the break-even points further away.
Long strangle maximum profit potential
If a stock's price goes up, the potential for profit is unlimited. If the stock's price goes down, the potential profit still exists but it will be based on the value of the option with the lower strike price minus the price of the debit when you paid for the option.
Long strangle maximum loss potential
The maximum losses for a long strangle strategy are limited to the net debit amount you paid to enter the trade.