Straddle vs No Transaction Strategy
- April 20, 2022
It is vital to use a strategy when you choose options trading in Australia.
A popular option to hedge a market position, the straddle trading strategy is a “long strangle” or an “Iron Condor.” The terms refer to the location of the bought and sold options. A long call straddle involves buying both a call and put at-the-money (ATM), while a short (short) calls and puts at two different strikes, but close to each other (but not ATM).
Straddles give investors big profits if stocks move either way by expiration. They can make money even when markets don’t go anywhere. Imagine you buy an out-of-the-money (OTM) call, and OTM put and pay no net premium.
A no transaction or strangle strategy is a hedging strategy that involves the purchase of a put option and a call option on the same underlying security, with both options having the same expiration date. The trade is typically executed at the money or just out-of-the-money to keep costs down. When the stock price moves against the investor, they cover their position. And when the price moves in favor of the trade, investors make money on both contracts.
Which Legs of the Strategy are Closed Out Upon Expiry?
Straddles can be closed out early if they become profitable or under certain circumstances for some more complex reason. It is done by offsetting the short option position through an equal and opposite transaction before expiration (known as “closing out” your option positions). The strangle does not have this luxury because both legs are open until expiration, so much like a calendar spread, you keep it until expiry.
Pay When Opened/Break-Even Point
When a straddle is opened, you must pay when it is established. When a strangle is opened, you will not have to pay upfront or at any time. However, if the stock price never changes, your break-even point for a straddle would be equal to the strike price plus premium paid, while for a strangle, it would be equal to the strike price minus premium received.
Straddles are profitable if expiration arrives, and both options still exist with some time remaining until expiration. If this happens, the investor makes money on both contracts because his short option becomes worthless while their long call has intrinsic value because the stock price is above the long call’s strike price.
A strangle is profitable when expiration arrives and either both options have intrinsic value or if one option has a higher intrinsic value than the other. For example, if an investor purchases a single call with a low strike price and sells a call at a much higher strike price, they will profit from that single high-priced option regardless of any time value remaining in it. If only time value remains in both contracts, then the total return will equal the difference between those two options’ respective intrinsic values.
The strike price is the same as the call and puts options. Also, all four legs of a straddle are at this strike price. Only the short option (call or put) has this strike price for strangles. The long option has either a higher or lower strike than the short option depending on whether it’s a Call Strangle or Put Strangle, respectively.
The time decay increases exponentially because the longer an investor holds a position in both options, the more money they lose from paying time premium without offsetting profits from underlying asset movement. Because there cannot be any intrinsic value in options that don’t exist, this means that the straddle will lose money until expiration arrives.
The time decay for a strangle follows the same principle but becomes less significant because of all the other differences listed earlier. That is to say, if price movement doesn’t happen, it won’t be profitable anyway, so there isn’t much long option time premium to go down. Of course, should price movement occur, things change in favor of the strangle due to something called “greeks”.