Options Strategies

Strategy Number 10 - Long "Strangle"

Market dATA
DJ Index 100 points
Prices
Call 120 $500

Put 80 $500

Strategy name:

Long "Strangle".

Recommended use of strategy

Expectation of especially high level of volatility of the DJ Index. This strategy is similar to the "Straddle" strategy, but profits are obtained only at a higher level of volatility.

For the purpose of example, we will assume that a war is expected in the next two months (which will result in very sharp fall in the DJ Index), while at the same time there an identical chance of a peace treaty being signed (which will result in sharp increase in the DJ Index).

Strategy components

  1. Buying a Long Call option outside-the-money (at a strike price which is higher than the DJ Index).
  2. Buying a Long Put option outside-the-money (at a strike price which is lower than the DJ Index).

For example: Buying a Long Call 120 option at a price of $500, and buying a Long Put 80 option at a price of $500.

Expenses / Income from building the strategy

Expenditure of $1,000.

Strategy graph:

1

Auxiliary table for building the profit line

 

 

DJ Index
(Horizontal axis)
(Fixed expenses)/ fixed income Variable income
(Call contribution)
Variable income
(Putl contribution)
Total profit / (loss) 
(Vertical axis)
2+3+4
1 2 3 4 5
50 ($1,000) --- $3,000 $2,000
60 ($1,000) --- $2,000 $1,000
70 ($1,000) --- $1,000 $0
80 ($1,000) --- --- ($1,000)
90 ($1,000) --- --- ($1,000)
100 ($1,000) --- --- ($1,000)
110 ($1,000) --- --- ($1,000)
120 ($1,000) --- --- ($1,000)
130 ($1,000) $3,000 --- $0
140 ($1,000) $2,000 --- $1,000
150 ($1,000) $3,000 --- $2,000

Strategy analysis:

Source of profit        

We profit on a sharp change in the DJ Index. When the index goes up we gain on the Long Call. When the index goes down we gain on the Long Put.

Source of loss           

Cost of building the strategy. The loss is maximized when the DJ Index moves in narrow range, and is limited to the cost of purchasing the options.

 

Break-even point

When the profit from the Call option or from the Put option equals the cost of the strategy totaling $1,000. This occurs when the index is at 130 points or 70 points.

Strategy Number 10 - Long "Strangle"558  Strategy Number 10 - Long "Strangle"