by Karim Rahemtulla, Investment Director, Smart Profits Report
In my column last week, I showed you how to use straddle options to take advantage of market/stock volatility when the direction is uncertain.
This week, we hop over the fence to the straddle’s sister strategy - the strangle options play.
To refresh your memory, a straddle is when you essentially bet on both sides of a trade by using options that have the same strike price and same expiration date.
For example, if you like Bank of America (NYSE: BAC), currently trading around $12, you could buy a $12 call option and a $12 put option. In doing so, the goal is that once the stock moves in a particular direction, one option will move high enough that it offsets the loss from the other one - and more.
With a strangle option, the basic goal is exactly the same, but the trading strategy is slightly different. Here’s how it works…
Reasons to Use A Strangle Option vs. Straddles
The main reason to use a strangle option over a straddle is to lower your cost on the trade.
Like straddles, strangle options also involve buying a put and a call option. But the difference is that instead of buying a call and a put with the same strike prices at or near the current share price (at-the-money option), strangles involves buying a call and put with different, out-of-the-money strike prices.
Let’s take our Bank of America example and assign some prices to various strikes.
STRADDLE PLAY (In or At-The-Money Options)
- BAC January 2011 $12.50 calls $3.75
- BAC January 2011 $12.50 puts $4.00
STRANGLE PLAY (Out-Of-The-Money Options)
- BAC January 2011 $10 puts $2.65
- BAC January 2011 $15 calls $3.00
As you can see, the strangle option play costs more than $2 less.
