Option Strategies - Strangles

Strangles

Salient Features          

a) Market is expected to take volatile move and remain outside a certain range of prices.
        b) Unlimited profit and limited loss

Introduction:

When an investor expects the prices at the time of expiry of contract to remain outside a level of prices, he may enter into the Strangles strategy, which is created by buying a call of higher level and buying a Put of lower level. Both of these price levels (of buying Call & buying Put) are nearly the boundaries, which he expects the prices to remain outside. If the prices remain outside the boundary he makes a profit otherwise loss. Let us take an example to understand this in detail- an investor takes following positions on 27th May 2005 when Nifty Spot was Rs.2070. Action Option type Strike Premium Total investment Long Call 2100 24   Long Put 2000 18 42

Here he buys Nifty Call and Put option of Strike price Rs.2100 and Rs.2000 respectively for which he pays a net amount of Rs.42 as premium (Rs.24 paid for Long Call position and Rs.18 paid for Long Put position) to create the position. His cash flow at different levels of Nifty closing on 30th June05(last Thursday of the following month) are as follows: Index Long call Long put Investment Cash flow 1850               -            150 -42                 108.00 1900               -            100 -42                   58.00 1950               -              50 -42                    8.00 1960               -              40 -42                   (2.00) 1975               -              25 -42                  (17.00) 2000               -              -   -42                  (42.00) 2050               -              -   -42                  (42.00) 2100               -              -   -42                  (42.00) 2125               25            -   -42                  (17.00) 2140               40            -   -42                   (2.00) 2150               50            -   -42                    8.00 2200             100            -   -42                   58.00 2250             150            -   -42                 108.00

Thus it is clear from above example that his profits will occur when the Index closes beyond a certain range of prices (here it is Rs.1960 to Rs.2140) whereas in case of Index closing within this range he will make loss.