A long strangle is an options trading strategy where you purchase both an out-of-the-money (OTM) call option and an out-of-the-money put option on the same underlying asset with the same expiration date. This strategy is particularly useful when you expect a significant price movement in the underlying asset but are uncertain about the direction of the move. Mechanics:
Buy a call option with a strike price higher than the current market price of the underlying asset.
Buy a put option with a strike price lower than the current market price of the underlying asset.
Both options must have the same expiration date.
Let’s assume you are trading stock XYZ, which is currently priced at $100. You expect a big move due to an upcoming earnings report but are unsure whether the stock will go up or down.
Strike price $110, premium $2.
Strike price $90, premium $3.
Your total investment (premium) is $5 per share. The maximum loss is limited to the total premium paid for both options. In this example, that is $5 per share.
Break-even points:
Strike price of the call + total premium paid = .
Strike price of the put - total premium paid = .
The strategy becomes profitable if the stock price moves significantly beyond either break-even point.
Notice the asymmetry buried in the example: the $90 put cost $3 while the equidistant $110 call cost only $2. Black-Scholes, with its single flat volatility input, would price the two legs symmetrically; the real market does not. Out-of-the-money equity puts trade at persistently higher implied volatilities than equidistant calls — the volatility skew (or “smirk”) — because the realised behavior of equity indices is asymmetric: rallies grind, crashes gap. End investors persistently bid OTM puts for portfolio insurance and persistently sell OTM calls for yield, and the dealers in the middle charge for the imbalance. The practical consequence for a long strangle is that your downside leg is structurally more expensive than your upside leg of equivalent distance. Two corollaries follow. First, your breakevens are not symmetric around the current price even before you draw them; the put-side breakeven sits closer than the simple “strike total premium” arithmetic suggests once you account for which leg cost more. Second, when you are tempted by a “cheap” strangle in a quiet market, check the skew before declaring it a bargain: low at-the-money implied volatility with a steep skew means the index options market is already pricing the next gap-down, and you are paying for it whether you noticed or not.
To calculate optimal strike prices for a long strangle strategy, follow these steps:
Determine the current market price of the asset.
Use historical volatility or implied volatility from options pricing models like Black-Scholes.
Decide the expiration date of the options, typically a few months out.
Use the formula for one standard deviation move:
Choose a call option with a strike price above the current price and a put option with a strike price below the current price, both within the expected price range. Typically, 5–10% out-of-the-money strikes are common.
Example: if the current price is $100, volatility is 20%, and the time to expiration is 3 months (0.25 years):
Choose a call option with a strike price around $110 and a put option with a strike price around $90.
Your maximum loss is capped at the total premium paid. If the underlying asset experiences a significant move, the returns can be substantial. You don’t need to predict the direction of the price movement, just the magnitude. Analyzing the historical volatility of the underlying asset can provide insights into the potential for significant price movements.
While cheaper than a straddle, the combined cost of two OTM options can still be substantial. Both options will lose value as they approach expiration if the underlying asset does not move significantly. The underlying asset must move significantly for the strategy to be profitable, more than the total premium paid.
Best used in volatile markets or when a significant event (earnings report, regulatory decision) is expected. The timing of the event relative to the expiration date is crucial. If the event occurs too close to expiration, there may not be enough time for the price to move sufficiently. High implied volatility can increase the cost of options, making the strategy more expensive.
A long strangle capitalizes on significant price movements without needing to predict the direction. However, it requires careful consideration of timing, market conditions, and the cost of premiums.