Options Trading

Straddles and Strangles

 

Straddles and strangles are not as popular as spreads. However, they can offer a distinct advantage: your profit is not capped at the start of the trade. Thus, you could potentially show unlimited gains.
Unlike spreads, a straddle or strangle involves trading both a Call option and Put option on the same security.
The downside to this trade is that it can get expensive and your losses can be much higher than with a simple spread.
As with spreads, there are distinct applications of straddles and strangles, depending on how the underlying stock is performing.
Here are the different types of straddles and strangles, as well as their applications:

Long Straddle

Buy one Call option and one Put option at the same strike price for the same expiration date.
With the Long Straddle, you're expecting the stock to make a dramatic move either up or down - the direction doesn't matter. With a Long Straddle, you buy both a Call and a Put contract. The options themselves aren't too expensive.  However, they can become expensive if the stock doesn't move far enough in the forecasted direction to make a profit above the expense of the options.

Short Straddle

Sell one Call and one Put at the same strike price for the same expiration date.
The Short Straddle is used when you expect the stock to move in a flat trading range. This strategy requires you have at least Level 4 and possibly Level 5 trading authority. With the Short Straddle strategy, sell both a Call and Put. This play uses naked positions and is considered a very risky transaction, resulting in the higher required trading authority.

Long Strangle

Buy one out-of-the-money Call and one out-of-the-money Put with the same expiration date.
To use a Long Strangle, your forecast for the stock is the same as it is for the Long Strangle. It doesn't matter whether the stock moves up or down, as long as it moves significantly in one direction or the other. One application for this strategy is the time period leading up to an earnings announcement. In this case, you don't have to be certain the stock will have a positive earnings announcement, as long as the stock moves either up or down due to the announcement.

Short Strangle

Sell one out-of-the-money Call and one out-of-the-money Put with the same expiration date.
As with the short straddle scenario, you are expecting the stock to trade in a flat range. It's considered a short trade because it involves selling a naked Call and a naked Put. The contracts you sell are a bit out-of-the-money for each position, giving you some flexibility for the stock to run, while allowing you the ability to potentially generate a nice profit. Please note that the naked Call and Put you sell will require a higher level of trading authority.