If you are looking for ways to generate profits from financial trading and you are presented with a scenario where the risks are limited but the upside for profit is unlimited, it has to be worth looking into more closely.
Options trading might have its own vernacular that takes a bit of getting used to, but learning about the long strangle or the long straddle, could prove rewarding.
Staying in touch with what is happening in the markets is often vital to success, which is why many investors visit sites like www.MoneyMorning.com/tag/stocks-to-buy/ on a frequent basis. Learning how the long strangle works, could also prove a lucrative move.
When Volatility Promises Profits
The basic premise of a long strangle, is where you create a long options trade based on your belief that you have identified an underlying high priced stock which is likely to experience a high degree of volatility in the price in the near future.
A long options strangle can best be described as an unlimited profit with limited risk strategy. They are debit spreads, as a net debit is taken in order to enter the trade.
A debit spread is when you take two options on the same underlying stock simultaneously. You purchase an option at the higher price and then open up a trade to sell at the lower band price simultaneously.
The net effect is that you are incurring a loss on the initial transaction, and the greater the disparity between the two prices, the higher the debit spread, meaning you will have a larger initial cash outflow situation to contend with in order to get in the game.
It may seem an alien concept to some investors that you would place a trade where there is an initial loss to contend with, but if you are right about the prospect of volatility with the stock price, your reward will be profits that wipe out the initial loss and put you into positive territory. It occurs when the purchased option you are sitting on acquires a greater value after you placed the original trade.
Straddle Or Strangle?
It is worth understanding the difference between a straddle and a strangle at this point, as they are both viable options as trading strategies and they both allow you the opportunity to gain from significant stock price movements.
Although both strategies work on the same line of thinking and growth strategy, which is to purchase an equal number of call and put options that have the same mirrored expiry date, the fundamental difference between the two is that the straddle only has the one common strike price to watch over.
When you place a strangle options trade you are covering both bases and looking to make a gain if the price subsequently rises or falls by having both a put and call option, whereas with a straddle trade, this is a single trade, in either direction.
A classic scenario where a strangle would be deployed is when you know that a stock is about to release some financial results in the next few weeks, but you are unsure whether the news is going to be good or bad for stockholder, meaning the stock value could rise or fall when the results are released.
If you believe that there will be a noticeable reaction when these results are released, placing a straddle options trade will mean that if the stock falls sharply or rises significantly, and you have guessed correctly which way, you could make some decent profits.
An options trader will often consider using a strangle when they have a firm idea of which direction the stock price is likely to be headed. By placing a call and put option you are potentially providing yourself with an element of protection if the stock moves in the wrong direction to your prediction.
When To Make A Move
Timing can be everything when it comes to investing in general and that is definitely the case when it comes to options trading, so when is a good time to strangle or straddle?
The most obvious case for this sort of trade is when you are aware that a major news event or company announcement is likely to impact on a certain stock or sector in general, such as a spike in the price of crude oil or some other commodity for example.
You will find that options traders use this type of strategy prior to an earnings announcement, as this is often a time where a positive or negative reaction to news will likely move the stock in a certain direction.
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