Straddle vs. Strangle Options Compared

What’s the most obvious method to generate a profit in the stock market?

It might seem like a funny question – at face value, investing in the stock market seems simple. An investor buys a stock and if the right call was made, the price goes up. Once sold, the profits can be pocketed.

But that isn’t the only way to make money from price fluctuations. Strategies such as short-selling make a bet that the price of an asset will drop – but most strategies like these come with a lot of risks, and are relatively hard to pull off. 🎚

That’s where straddles and strangles come in. These two approaches make use of stock options – derivative contracts that derive their value from the price of an underlying asset. So, what’s the trick?

In essence, straddles and strangles seek to profit from volatility – significant price swings in either direction. With these two approaches, if a stock moves either up or down by at least a certain degree, the options trade will be profitable.

Although derivatives such as options often get a bad rap, there’s no denying that the options market has hit record highs – but most retail investors still end up with the short end of the stick. Derivatives do require more experience and careful planning – but with enough knowledge and the right tools, they provide a great avenue for retail investors to profit.

Investors who have already racked up some notches on their belts and are ready to set off in the arena of derivatives should give straddles and strangles a try. These approaches require basic knowledge, but nothing way too technical – and the transaction costs are manageable for most investors.

What is a Straddle? 📘

A straddle is one of the two approaches that we will cover today. The straddle is a neutral options strategy without a directional bias – to put it simply, this means that to successfully utilize a straddle, an investor doesn’t have to predict whether the stock will go up or down.  Both retail investors and large institutional investors like Goldman Sachs use this approach. So, how does it work?

A straddle works by purchasing two options contracts, one of them a call and the other a put, at the same strike price, with the same expiration date. The strike price that is used for straddles is the stock’s price at the time of purchase. If a stock trades at $17 and an investor wants to pull off a strangle, he will purchase a call and put with a strike price of $17. Purchasing options contracts is much cheaper than purchasing stocks, especially when using the right binary options broker, but it still costs some money – this amount is referred to as a premium.

As long as the stock price moves far enough in one or the other direction, so that the premium can be paid off, all of the additional profit can be pocketed. A call option allows an investor to buy a stock at a certain price, while a put option allows an investor to sell a stock at a certain price.

Because the strike prices are the current price of a stock, if the price moves significantly in one or the other direction, one of the two underlying options contracts (either the put or the call) will not only cover the other but secure additional profits.

How to Spot a Straddle? 🔍

Straddles might appear simple at first glance, and although they aren’t the most complex options trading strategy, they still require a bit of know-how to pull off properly. The best way to explain everything is by using a simple example.

Let’s say that a stock is currently trading at $40. Purchasing a call option for the stock comes with a premium of $3, while the put option comes with a premium of $1. All in all, the total expense of the straddle per share is 4$.

So, what has to happen for the investor to profit? It is simple – just take the current share price and divide it by the combined premium – once that is done, it is simply a matter of multiplying by 100 to get a percentage. In this case:

This is the price movement that has to happen for the straddle to be profitable. In other words, in this example, so long as the stock price went either above $44 or below $36, the straddle would be profitable.

In order to spot a good opportunity for a straddle, investors need to pay attention to a couple of metrics – such as the Greeks (delta, gamma, vega, and rho), as well as implied volatility.

What is a Strangle? 📙

The second strategy that we’ll be covering today, the strangle, and it works in a similar way to a straddle – but there are a couple of key differences. 

With straddles, investors purchase call and put options with a strike price corresponding with the asset’s current trading price, and both options contracts have the exact same expiry date. With strangles, the call and put also have the same expiry date – but the strike prices are different.

So, what is the advantage in purchasing a call and a put with different strike prices? It’s simple – straddles are great when an investor anticipates a sharp price swing but is unsure of the direction. Strangles, on the other hand, fill a different niche. When an investor is certain that there will be a price swing, but the odds favor either an upward trend or a downward trend.

The strike price of the options contract that corresponds to the expected trend (upward or downward) is placed closer to the asset’s current price – while the other options contract’s strike price is up to the investor, but should also be close to the current asset price.

If it turns out the investor was right, and a sharp swing in the expected direction occurs, the call option will quickly become very profitable. If however, the investor was wrong, and the opposite occurs, the put options either serve to soak up some of the damage and prevent further losses, or they can themselves become profitable, provided that the opposite swing occurs to a large degree.

How Does an Options Strangle Work? 👷‍♂️

As we’ve discussed, both strangles and straddles become profitable when the underlying asset used for the options contracts experiences a large price change. However, due to the slightly more complicated nature of strangles, it also takes a little more legwork to determine when a strangle will be profitable. It all boils down to this – with strangles, there are two distinct breakeven points – with straddles, there is only one.

Just as we did for straddles, we’re going to use a hypothetical example here to illustrate. Let’s use the same hypothetical example – an underlying stock that is currently trading at $40 per share.

If an investor determines that the stock is more likely to go up than down, they would purchase a call option that is close to the asset’s current price. For this example, we’ll use a call option that gives the investor the right to purchase the stock at $43 per share. For the put option, let’s use $37 as a benchmark. Our hypothetical call option comes with a premium of $2.50 per contract – while the put option comes with a premium of $2.25 per contract. 🧮

Once we add that up, the total premium for the strangle is:

To calculate the two breakeven points, we take the strike price for the call (in this case, $43) add the premium of $4.75, and get a total of:

So, the first breakeven point is $47.75.

For the second breakeven point, we take the strike price of the put option – in this case, $37, and subtract the $4.75 premium. In this case, the equation looks like this:

This is how we find the second breakeven point.

To sum it all up – using these numbers, if the stock went over $47.75 or under $32.25, the strangle strategy would have been profitable. In all other cases, the investor would end up losing money – although the losses are reduced the closer the asset’s price is to either break even point.

Straddle vs. Strangle: Differences ⚖

Straddles and strangles are often grouped together – and with good reason. These options trading strategies use similar methods, require a similar level of skill, and are the methods most options traders turn to when they’ve mastered simple single leg strategies.

Although both straddles and strangles operate as two-leg strategies (meaning that they utilize both call and put options), and both use options contracts with the same expiration dates, there are a couple of subtle differences between them. 

In other words, straddles and strangles mix, match, and combine to form more complex, multi-leg options strategies – so knowing the ins and outs of both of them is crucial if one is to understand the more technically demanding (and possibly profitable) options trading strategies such as butterflies and condors down the line.

Strike Price 💵

When using straddles, both the call and put option used have the same strike price. This can all sound quite confusing – particularly to beginners, so we’ll use an example.

Let’s say a stock is trading at $25. Due to the launch of a new product, coupled with the release of an earnings report, an investor suspects that a large price change is in order. However, they are not sure what direction the move in price will take.

In order to profit, the investor then purchases a call and put option at the same price – in this case, $25. If the stock experiences a significant upswing in price, the call option will become profitable – if, however, the stock’s price drops, then the put option becomes profitable. So long as a big enough change occurs, a straddle is profitable.

Strangles, however, are a different story. With strangles, there is an element of directional bias – this approach is used when an investor ascertains that the likelihood of a swing in one direction is higher than the likelihood of the opposite occurring.

In the case of a strangle for a stock trading at $25, let’s say that the investor thinks that an upswing is more likely to occur. A call option will then be purchased with a strike price of $27 and a put option with a strike price of $22. The put option still provides some downside protection, but because of the different strike price, it is much cheaper than an equivalent strangle put.

Implementation Costs 🔧

Straddles and strangles are two-leg strategies that utilize both calls and puts – but seeing as how the strike price is different, the premium required to purchase the relevant options contracts is different. And this isn’t a matter of chance – the premiums associated with implementing a straddle are always higher than those associated with implementing a strangle.

The difference in premiums and the difference in implementation costs go a long way in differentiating the two approaches. For starters, they serve as a barrier – the higher costs associated with straddles make them less appealing to investors with smaller accounts – and secondly, this also serves to make strangles less risky overall in comparison to straddles.

However, on the whole, both of these approaches are relatively safe – there is a very limited downside in the case that the stock in question trades sideways, but a lot of potential upside.

Directional Bias 👉

Directional bias is a term that means an investor expects the markets to move in a certain direction – and makes investment choices according to that expectation. With straddles, there is no directional bias – the criteria for success is that the market moves significantly, but the direction of the move is completely irrelevant.

On the other hand, there is some degree of directional bias present when it comes to strangles. This stems from the first difference covered in this list – the strike price. While straddles are made by purchasing call and put options at the same strike price, strangles utilize different strike prices.

If an investor thinks that the odds of an asset’s price moving in one direction are higher than the other, adding directional bias is simple. For example, if the investor thinks that the asset is more likely to rise in price, then they will purchase call options that are closer to the current price of the asset.

So, what does this boil down to in practical terms? When investors are unsure of which way the market or the price of a certain asset is going to go, straddles are the superior option. However, if there is a higher likelihood of things going one way rather than the other, an investor should opt for a strangle.

The Longs and Shorts of Option Straddles and Strangles 📚

Now that we’ve covered the basics surrounding options, straddles and strangles, how they work, and how they differ from one another, we can move on to something a bit more complex.

Though easy to implement and rather beginner-friendly, straddles and strangles aren’t completely one-dimensional – in fact, the entire maneuver can be done in reverse. This is what is referred to as a short straddle and a short strangle.

In essence, short straddles and short strangles seek to take the other side of the bet compared to long straddles and long strangles. If the traditional approach seeks to profit from volatility, then the short approach seeks to profit from sideways trading or lack of volatility. Of course, to do that, investors will have to write and sell options contracts and collect premiums – but there is a lot of profit to be made in this way also.

Long Straddle vs. Short Straddle ⚔

Long straddles need no introduction – whenever we talk about straddles without specifying whether they’re long or short, we’re actually talking about long straddles. Everything that we’ve explained up to this point refers to long straddles.

Short straddles, on the other hand, have quite a few important differences. They aren’t much more difficult to execute than long straddles, but they rely on completely different market conditions to be profitable and carry significantly higher risks.

In short (pun intended), whereas long straddles rely on significant changes in the price of the underlying asset to become profitable, short straddles rely on the very opposite – flat or sideways price action, without any significant changes.

 It is best to think of it this way – the stock market is a zero-sum game. Whenever an investor makes money, someone else loses money. Buying a stock at an opportune moment means that someone else sold it when they should have held it.

In terms of short straddles, investors earn money by providing the options contracts for a straddle, but with the expectation that they will fail. For long straddles, an investor buys options contracts – for short straddles, an investor writes and sells options contracts.

So, what does this all mean in the end? With short straddles, the investor sells options and collects the premium. If they were right, and the stock doesn’t experience a large change in price, they get to keep the premium – but if they were wrong, they will lose a lot of money.

It boils down to this – with long straddles, there is limited downside risk and unlimited upside potential. With short straddles, the opposite is true – the upside is very limited, and the potential downside is unlimited.

Long Strangle vs. Short Strangle 🤺

Everything that we’ve said about the differences between long straddles and short straddles also applies in the case of strangles. The basic differences between the two approaches still stand – with short strangles, investors sell call and put options contracts with different strike prices and the same expiry date.

In order to profit off of a short strangle, an investor has to correctly predict that other market participants are anticipating a large price swing in a certain direction – and that this swing won’t come to fruition.

Proving negatives, of course, is nigh-impossible – but the fact that short-term moves, technical analysis, news trading, and market psychology have such a huge impact on investor sentiment means that it is highly unlikely that an underlying stock’s price will move sideways if there is even a single important event related to the company that is happening.

Just as it is in the case of short straddles, short strangles carry very limited profit potential, and have unlimited risk. In short, these are highly risky strategies that are usually not worth it – if an investor thinks that a stock is going to trade sideways, applying a different strategy or simply not participating is usually a much better choice.

Examples of Option Straddle and Strangle 📝

Let’s use two examples that are a bit closer to home to cap things off. For these examples, we’ll be using two real, highly-traded stocks, as well as their share prices at the time of writing – however, the option premiums will be hypothetical, so as to not complicate things too much.

Almost everyone who doesn’t live under a rock has probably heard about Tesla, Elon Musk’s revolutionary EV company. In light of the media coverage of Musk’s acquisition of Twitter, Tesla shares had a rough time in mid-2022. As of the time of writing, they are trading at $750 per share.

An investor who was certain that there would be a large swing in the share price would purchase calls and puts with a strike price of $750. In our hypothetical example, let’s say that the premiums amounted to $40.

If the price at the time of expiry was equal to or greater than $790, or equal to or less than $710, then the long straddle would be profitable.

On the other hand, let’s use Netflix for our strangle example. As of mid-2022, the year has not been kind to Netflix – with the issues of advertising and password sharing causing share price to enter free-fall in April of 2022. As of the time of writing, Netflix is trading at approximately $200 per share.

If an investor wanted to make a bet that the share price will recover, a strangle with a call option at $220 and a put option at $150 could be put in play. For our example, let’s say that the options premiums amounted to $30.

With strangles, there are two break even points – in this case, the first breakeven point is the strike price of the call ($220) plus premiums ($30) for a breakeven point at $250. The other breakeven point is found when we take the put strike price ($150) and subtract the premium ($30) for a breakeven point of $120.

Let’s Discuss Implied Volatility 💬

As mentioned, the strategies that we’ve discussed today are based on significant changes in the underlying asset price which make the options contracts profitable. In essence, when applying these two approaches, investors are looking for one thing and one thing only – volatility.

Investing in simpler asset classes such as stocks, ETFs, and the like should never be done without research – and that holds even more true for derivatives such as options. When applying strangles or straddles (looking for volatility), there are a lot of factors to consider – media coverage, major events such as earnings reports, product releases, fundamental data – and while all of that is well and good, it isn’t enough.

When approaching options trading, there is a whole new set of metrics specialized for the task that is ahead of investors – these are referred to as the greeks. We’re not going to be covering them today, seeing as how they deserve a separate guide, but we will introduce one metric that is closely related to the Greeks, but much easier to implement – implied volatility.

Designated by the Greek letter sigma (Σ), implied volatility is often used to determine the price of options contracts – high implied volatility makes options more expensive. Implied volatility or IV is a measure of how likely it is that a stock’s price is going to change – and how intense that change will be.

Factors such as supply and demand, interest rates, historic volatility, and others affect IV – which is calculated by using the Black-Scholes model. There’s no need to panic, however – most of the premier brokerages for trading options have tools that do the legwork for you.

Final Word: Which Strategy Suits You Better?

So, at the end of the day, which of these strategies should investors flock to? Well, that isn’t exactly a straightforward question, but there are a couple of key differences that make choosing the right play easier. 🎯

The first topic to consider is risk tolerance – because they require more capital and exhibit more volatility, straddles won’t be a good choice for investors who are risk-averse. On the other hand, the less-risky nature of strangles makes them a much more beginner-friendly approach,

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