Straddle Vs Strangle Options Strategy

If you are like most options traders, you may wonder what’s the best strategy between a Strangle and a Straddle. In fact, these two advanced options strategies have many similarities and often traders use one rather than the other without any particular reason.

I’ve received lots of questions from my students and the Straddle Vs Strangle Options Strategy debate is definitely something that needs to be clarified once and for all. Despite the fact that the two strategies look graphically similar - have a look at the risk graphs in the video below - there are some key differences which need to be considered in order to maximize the chances of success.

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Straddles Vs Strangles: Similarities

Let’s start with the similarities first. Both strategies are delta neutral, Vega positive, Theta negative and benefit from an explosive move of the underlying with a potential unlimited profit. They are delta neutral strategies because you can profit regardless of the direction of the market as long as there is a substantial move of the underlying either upwards or downwards in a reasonable amount of time.

These are Vega positive strategies as on both Strangles and Straddles you are an options buyer and purchase the implied volatility (IV) within them. It means that these strategies increase in value when IV rises and decrease in value when IV declines.

Theta negative means that both strategies are negatively affected by time decay losing value with the passage of time. As a result, with both Straddles and Strangles you never want to get too close to the options expiration. And both strategies offer a capped maximum loss and an unlimited potential profit with a substantial move of the underlying security.

Straddles Vs Strangles: Risk Graphs and Risk Profiles

The risk graphs are slightly different. Straddles have a V-shaped risk profile with the maximum possible loss at the lower end of the V shape and in correspondence of the unique strike price purchased. Instead, Strangles present a large base with a wider maximum loss area in between the two strike prices purchased. You can clearly see the slightly different risk profiles shapes in the above video.

Now this different shape is explained by the fact that the two strategies are made up of completely different strike prices. In a Straddle you purchase at-the-money (ATM) call and put options with the same strike price, while in a Strangle you purchase out-of-the-money (OTM) call and put options with different strike prices. ATM options are generally expensive as there is a high probability that these will be in-the-money (ITM) by expiration, while OTM options are normally cheaper as these have a much lower probability to be in-the-money (ITM) by expiration. OTM options carry time value only, while ATM options might carry some intrinsic value also.

The Main Differences Between Straddles and Strangles

All this makes a Straddle a more expensive strategy than a Strangle. However, and here is the main difference between the two strategies, the higher entry debit in a Straddle is counterbalanced by having a trade with slightly higher chances of success and much lower probability to experience the maximum loss.

In fact, the two breakeven points (BEP) - upside BEP and downside BEP - are normally further away in a Strangle meaning that the strategy needs more movement of the underlying security either upwards or downwards to become as profitable as a Straddle.

On the other hand, if the trade does not go according to plan and the underlying does not move enough in a reasonable amount of time, as the strategy gets closer to expiration, the loss you experience will be more significant with a Strangle as the OTM options purchased are going to lose their value at a faster rate than the ATM options purchased with a Straddle.

Strangles also have a higher probability of experiencing the maximum loss than Straddles because of the wider losing area in between the two strike prices purchased.

If the underlying security is trading between these OTM strike prices at expiration you get the maximum loss. Conversely, it is unlikely to get the max loss with a Straddle option strategy as the underlying security should be trading at expiration exactly at the ATM strike price.

Let me stress the point that both Strangles and Straddles are strategies that you want to hold for a limited time only and not carry all the way to expiration.

Straddle Vs Strangle Options Strategy: Conclusions

For instance, I initiated both options strategies on Caterpillar Corporation (CAT) on Thursday the 25th of May 2023. At the time, the underlying was trading around $210.

I built the Straddle strategy with the simultaneous purchase of 1 contract of the ATM $210 call option (expiration 17 Nov 2023) and 1 contract of the ATM $210 put option (expiration 17 Nov 2023).

Instead, the Strangle strategy was built with the simultaneous purchase of 1 contract of the OTM $220 call option (expiration 17 Nov 2023) and 1 contract of the OTM $200 put option (expiration 17 Nov 2023). The entry debit for the Straddle was $3561, while the entry debit for the Strangle was $2661.

It appears clear that Straddles can be way more expensive to trade. However, as a rule of thumb if you have enough available funds in your brokerage account, I recommend choosing this strategy over a Strangle. There are two occasions when a Strangle might be more convenient:

1. Firstly, if the underlying security is trading in between two strike prices. For instance, let’s go back to Caterpillar and imagine that the stock is trading at $205 and there is no ATM strike price. The two closest strike prices which can be traded are $200 and $210. In this case, opening a Strangle and using these two OTM strike prices is your only option to open the strategy on Caterpillar.

2. Secondly, if there are some implied volatility anomalies or volatility skews and the OTM strike prices carry lower implied volatility values than the average for that underlying security. In this case, the OTM strike prices might be more convenient to purchase, increasing the probability of their future appreciation in case of a rise in implied volatility.

Hopefully this clarify a bit for you the Straddle Vs Strangle Options Strategy debate. Please feel free to get in touch with further questions.

I’ll see you in the next release of the options trading diary.