A strangle is a good options strategy to pursue if a trader believes that a stock’s price will move significantly, but is unsure of which direction.
A strangle is also a good strategy if a trader believes that volatility is priced below a stock’s potential movement.
To purchase a strangle, a trader buys a long position in both a call and a put with different strike prices, often out of the money, but with the same expiration date.
For example:
Stock XYZ is trading at 40
If you were to buy a strangle on stock XYZ, you would simultaneously do the following:
Buy the XYZ June 45 Call
Buy the XYZ June 35 Put
For a total debit of $2
If the stock were to close between 35-45 on the June expiration, you will lose $2 as both the call and put would expire worthless.
If the stock were to close at 33 or 47, you will break even.
If the stock were to go below 33 or above 47, you will make one dollar for every dollar the stock moves outside of 33 or 47.
Here is a graph depicting the profit and loss of a Long Strangle:
