Straddles and strangles

with exapmles

1. Financial Derivatives(KMBFM05) Option Hedging Strategies (Part2) Straddle and Strangles Prepared by : Taru Maheshwari Sr.Asstt.Prof . ABESEC AKTU (Lucknow)

2. Straddles and Strangles Straddles  and  strangles  are both options strategies that allow an investor to benefit from significant moves in a stock's price, whether the stock moves up or down. ... The difference is that the  strangle  has two different strike prices, while the  straddle  has a common strike price

3. Long Straddle By buying both the call and the put, you are spending money, buying premium.  You need stock to move significantly in either direction and/or implied volatility to go up, all before too much time passes.  Your upside and downside profit potential are unlimited (until stock reaches zero) and your maximum loss is what you paid for the straddle.

4. Example Exercise Price Call Option Put ption payoff 1000 80 25 1100 55 40 95(BEP-1195 and 1005) 1200 35 55

5. Short straddle A short straddle, on the other hand, is a high risk position.  As you can see from the graph that losses are unlimited and profits max at the price received for the sale of the straddle.  Profits are only in the span of up or down the price of the straddle from the strike.

6. Long straddle and short straddle Long straddle Short straddle About strategy OTM call and Put option is bought simultaneously with same underlying asset and expiry date and same exercise price OTM call and Put option is sold simultaneously with same underlying asset and expiry date and same exercise price Market Neutral Neutral Option type Call & Put Call & Put No of Positions 2 2 Risk Limited Unlimited Reward Unlimited Limited Breakeven 2 2

7. Long Strangle (Buy Strangle) Short Strangle (Sell Strangle) When to use? A Long Strangle is meant for special scenarios where you foresee a lot of volatility in the market due to election results, budget, policy change, annual result announcements etc. The Short Strangle is perfect in a neutral market scenario when the underlying is expected to be less volatile. Market View NeutralWhen you are unsure of the direction of the underlying but expecting high volatility in it. NeutralWhen you are expecting little volatility and movement in the price of the underlying. Action Buy OTM Call Option Buy OTM Put Option Suppose Nifty is currently at 10400 and you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty at 10600 and at 10800. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves. Sell OTM Call Sell OTM Put Sell 1 out-of-the-money put and sell 1 out-of-the-money call which belongs to same underlying asset and has the same expiry date. Breakeven Point two break-even pointsA Options Strangle strategy has two break-even points. Lower Breakeven Point = Strike Price of Put - Net Premium Upper Breakeven Point = Strike Price of Call + Net Premium two break-even pointsA strangle has two break-even points. Lower Break-even = Strike Price of Put - Net Premium Upper Break-even = Strike Price of Call+ Net Premium"   Long Strangle (Buy Strangle) Short Strangle (Sell Strangle) Risks LimitedMax Loss = Net Premium Paid The maximum loss is limited to the net premium paid in the long strangle strategy. It occurs when the price of the underlying is trading between the strike price of Options. UnlimitedThe maximum loss is unlimited in this strategy. You will incur losses when the price of the underlying moves significantly either upwards or downwards at expiration. Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received Or Loss = Strike Price of Short Put - Price of Underlying - Net Premium Received Rewards UnlimitedMaximum profit is achieved when the underlying moves significantly up and down at expiration. Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid Or Profit = Strike Price of Long Put - Price of Underlying - Net Premium Paid LimitedFor maximum profit, the price of the underlying on expiration date must trade between the strike prices of the options. The maximum profit is limited to the net premium received while selling the Options. Maximum Profit = Net Premium Received Maximum Profit Scenario One Option exercised Both Option not exercised Maximum Loss Scenario Both Option not exercised One Option exercised Compare Risks and Rewards (Long Strangle (Buy Strangle) Vs Short Strangle (Sell Strangle))

8. Strangle Strangles have many of the same characteristics as straddles, but with a larger margin of error.  For a strangle you buy or sell both an out-of-the-money call and an out-of-the-money put of the same expiration but different exercise price.  Thus the premium paid or received is considerably lower than a straddle.

9. Example Exercise Price Call Option Put ption payoff 1000 80 25 1100 55 40 60 (BEP-1260 and 940) 1200 35 55