How would you like to profit from a stock that moves significantly in either direction? If so, then consider the long strangle strategy.

The key here is that you need large movement in the underlying stock for the trade to be profitable. It doesn’t matter which way the stock moves, though.

You’ll lose money if the stock price hasn’t changed much by the time the options contract expires.

In this guide, I’ll explain the long strangle options strategy so that you can determine if it’s right for you.

What Is a Long Strangle?

A long strangle involves buying an out-of-the-money call option and an out-of-the-money put option at the same time. Both options have the same expiration date and underlying security, but different strike prices.

A long strangle is a limited risk, unlimited gain options strategy. Your risk is limited to the amount of money you invested in the options. Your gain is unlimited because a stock can theoretically go up forever.

Some people confuse the long strangle with the long straddle. That’s understandable, because they sound the same.

The difference between a strangle and a straddle is that a straddle involves purchasing at-the-money call and put options with the same strike price.

Both strategies are profitable if the stock moves significantly in either direction.

Read Also: How Does A Long Call Spread Options Strategy Work?

When Would You Use a Long Strangle?

A long strangle is a perfect strategy if you think that a stock is poised to move a lot in the near future, but you’re not sure which way it’s going to move.

You’ll make money if the stock skyrockets or if tanks prior to contract expiration.

You’ll lose money if the stock stays flat.

The good news is that the most you’ll lose is the amount you invested in the options. There are no short positions in a long strangle, so you don’t need to worry about getting hit with a huge, unanticipated loss.

How Does a Long Strangle Work?

For starters, make sure that your online trading platform supports multi-leg orders. You’re going to need that feature because you’re opening two different options positions at one time.

Once you’ve determined that you can place multi-leg orders, find a stock that you think will move that will swing wildly in either direction in the near future.

Pro-tip: It might be tempting to think you can use this strategy on stock when the company is close to earnings. That’s because you might think that after an earnings announcement, the stock will move a lot to the upside or downside.

Resist that temptation. It’s often the case that the price of options contracts are already “baked in” around earnings and your trade won’t be profitable even if the stock moves noticeably.

Look for other factors that could cause a stock to jump one way or the other.

Once you’ve identified a stock, buy an out-of-the-money call option and an out-of-the-money put option. Make sure you buy the same number of contracts in both trades and use the same expiration date.

Keep in mind: since you’re long on both options, time works against you. That means as the contracts get closer to expiration, all other things being equal, your positions will erode in value.

You really need a nice price swing to earn a profit.

Read Also: How Does The Calendar Spread Options Strategy Work?

Real Life Example Using a Long Strangle?

Let’s say that Johnson & Johnson is trading at $133 per share right now. You think it might move quite a bit in one direction or another in the near future so you decide to enter into a long strangle trade.

You see that next month’s $135 call option is offered at $3.95 per contract and next month’s $125 put option is offered at $2.43. Those prices seem fair, so you decide to use those options in your long strangle.

You buy the $135 call option for $3.95. Remember, though, that options contracts are traded in blocks of 100 shares, so you actually spend $395 ($3.95 x 100).

Similarly, you spend $243 on the put option ($2.43 x 100).

Your total investment for the trade is $538 ($395 + $243). That’s also your maximum loss.

Let’s say you were right. JNJ moved up to $145 per share right at contract expiration.

That means your $135 call option would be worth around $10 per contract or $1,000 total ($10 x 100). Your put option would expire worthless because it’s way out of the money.

That’s okay, though. The overall trade is profitable.

You invested $538 and turned it into $1,000. That’s an 85% return in just one month!

What Are Similar Strategies related to Long Strangle?

Here are a few options strategies similar to the long strangle:

• Short Strangle – Involves selling, rather than buying, out-of-the money call and put options. It’s also a neutral strategy, meaning that it only makes money if the underlying stock stays relatively flat.
• Long Straddle – Involves selling put and call options at the same expiration date with the same strike price. Like the long strangle, it’s profitable if the stock moves in one direction or the other.
• Strap – A more bullish version of the long straddle. It involves buying twice as many calls as puts.

Long Strangle Compared to Other Options Strategies?

A long strangle is a limited risk, unlimited profit trading strategy. As such, it compares favorably with many other options strategies that limit both risk and profit, such as the protective put.

If you’re risk-averse, a long strangle is also preferable to options strategies that offer unlimited risk, such as the short call.

Perhaps one of the biggest downsides to the long strangle is that time works against you. Thanks to the natural time decay of options, you’ll see an unrealized loss every day if the stock doesn’t make a large move in either direction. If the stock stays that way at contract expiration, that unrealized loss will become a realized loss.

Advantages & Risks of Long Strangle?

Advantages

• Limited risk – You can only lose the amount that you put into the trade and no more.
• Unlimited profit potential – The sky’s the limit when it comes to how much you can make off the trade.

Risks

• Time decay – Time works against you in a long strangle. As the contract gets closer to expiration, the value of your options contracts will erode.
• Requires significant price swings – It’s typically not enough if the underlying stock moves just a couple of points up or down. You need it to go much higher or much lower to earn a positive return.