Straddles and strangles: capturing price movements with listed options
Options trading has become increasingly popular among traders in Singapore due to its flexibility and potential for high returns. However, with so many strategies available, it can be overwhelming for traders to choose the correct one that suits their investment objectives and risk appetite. Traders use straddles and strangles to capture price movements in the options market. These two strategies are considered neutral, as they do not require a trader to have a bullish or bearish outlook on the underlying asset. Instead, their goal is to profit from volatility in the market. This article will discuss how traders can use straddles and strangles to capture price movements with listed options in Singapore.
Understanding straddles
A straddle is an options trading strategy that involves buying a call option and a put option with the same strike price and expiration date. This strategy can be used when a trader anticipates a consequential price fluctuation in the underlying asset but is still determining the direction of the movement. By purchasing both a call and put option, the trader has unlimited profit potential if there is a consequential price fluctuation, regardless of whether the market goes up or down. However, this also means the trader must pay for both options, costing more than other strategies.
Traders can use straddles when an upcoming event, such as an earnings announcement or a product launch, could affect the stock’s price. By buying both a call and put option, the trader can benefit from any consequential price fluctuation in either direction. This strategy is also useful when a stock has been trading in a tight range and the trader expects a breakout soon.
Executing a straddle trade
To execute a straddle trade, traders must purchase both a call and put option with the same strike price and expiration date. Choosing an expiration date that allows enough time for the anticipated price movement to occur is essential. The cost of the straddle will depend on factors such as the stock’s current price, implied volatility, and time until expiration.
Once the trade is executed, there are three possible outcomes:
1) The stock’s price remains unchanged – in this case, both options will expire valuelessly, and the trader will lose their initial investment.
2) The stock’s price moves significantly in one direction – in this case, either the call or put option will become profitable, while the other expires worthless. The profit from the winning option can exceed the total cost of both options, resulting in a net profit for the trader.
3) The stock’s price moves in both directions – this is known as a “whipsaw” and can result in both options expiring worthless, causing a loss for the trader.
Understanding strangles
A strangle is similar to a straddle, but instead of buying a call and put option with the same strike price, the trader purchases options with different strike prices. This strategy is used when a trader expects consequential price fluctuation but is still determining the direction.
A long strangle strategy entails purchasing an out-of-the-money (OTM) call and put option. An OTM option has a strike price that differs significantly from the underlying asset’s current price. This approach is more cost-effective than a straddle, as it involves buying OTM options but offers a lower profit potential.
A short strangle involves selling an OTM call option and an OTM put option. This strategy generates income upfront for the trader. Still, a higher risk is applied as the trader exposes themselves to unlimited losses if the stock’s price moves significantly in either direction.
Singapore option trading is regulated by the Monetary Authority of Singapore (MAS). Therefore, traders must know the rules and regulations surrounding options trading in Singapore.
Executing a strangle trade
To execute a strangle trade, traders must purchase an OTM call and put option. Choosing the correct strike prices is crucial in this strategy as it will determine the initial cost of the options and the potential profit/loss.
If the stock’s price remains unchanged, both options will expire valuelessly, causing the trader a loss. If there is consequential price fluctuation in one direction, the call or put option will become profitable, while the other expires worthless. However, unlike a straddle, the profit from one option may not exceed the total cost of both options due to the difference in strike prices.
If there is a “whipsaw,” both options may expire valuelessly, resulting in a loss for the trader. However, if there is substantial price movement in one direction, a strangle has lower break-even points than a straddle, making it a more cost-effective strategy in certain situations.
Advantages and disadvantages of straddles and strangles
One advantage of using straddles and strangles is that they can be used for any underlying asset, including stocks, currencies, commodities, and indices. It gives traders a wide range of options to choose from.
Another advantage is that these strategies are considered neutral, making them suitable for traders who do not have a solid bullish or bearish outlook on the market. They also allow traders to profit from volatility rather than just price movement in one direction.
However, traders must understand that these strategies involve higher costs due to the purchase of multiple options. They also require precise timing and a consequential price fluctuation to be profitable, making them riskier than other strategies.
