Long Strangles are fantastic options spreads to use in situations where you’ve identified a catalyst that is likely to result in a big move either up or down, but you’re not sure which? These trades are ideally put on when implied volatility is low, otherwise you’re likely paying too much for the spread.

The spread is composed of an equal amount of long out-of-the-money puts and long out-of-the money calls. A common practice is to select the 25 delta strikes, but this is not a requirement.

In the case of the example above where a stock is currently trading at $100, one could buy both the 90 put and 110 call to create a nice balanced strangle. At the time of trade initiation, the spread will be delta neutral and long gamma — which means if the market goes down, your position essentially gets more and more short. And conversely, in rising markets, your position will get more and more long (in terms of delta), as displayed by the blue line in the chart above.

Long Straddles enjoy similar characteristics as Strangles, the big difference being you’re buying the same strike call and put (usually at-the-money) and likewise paying more for the spread since you’re purchasing the most expensive options on the board (in terms of premium). For example, the P/L graph for a straddle on the same stock above might look like this:

Whereas the long strangle might cost you $1.50 at trade initiation, a long straddle in the same stock might cost you $7.50. In both cases, the premium you paid is the most you can lose. The strangle, has a higher chance of both options expiring worthless, while it is more than likely either the long call or long put in the straddle will expire in the money and therefore will have value.

My preference is to trade long strangles over long straddles because they are cheaper, and because you get more bang for your buck if the anticipated big move happens.

Short Strangles and Straddles are common strategies for net premium sellers who like to engage in credit or “income” trades. In most cases, these players are looking to do the opposite of buyers of Long Strangles or Long Straddles when volatility is relatively high and these spreads cost more money. The thinking is that volatility is likely to mean revert (ie, go back down) and thus options premiums will decay faster. And additionally, the higher premiums allow the short seller to have wider breakevens on their trades. So as long as the stock doesn’t move too far in either direction, they will likely have an opportunity to cover their short Strangle or Straddle for less than the premium they collected at trade initiation, resulting in a net profit. This is a high probability trade and very popular with the investing public.

Main drawbacks of these strategies are that due to being naked short options, there is often a large margin requirement to hold these positions, and your risk is theoretically undefined. Tread very carefully when engaging in spreads that contain naked short options. Position sizing is paramount here. If you trade these too big, it’s only a matter of time before a big move takes you out of the game. It will happen. And it only needs to happen once, then you’re gone. Always err on the side of trading these spreads too small.

Position Management:

For long Strangles and Straddles, I tend to look to close them once I get to about 30 days to expiration if the underlying is between the strikes (Strangle) or inside my breakevens (Straddle). If they are outside those ranges and the position is making money, I’ll often let these ride and try to take advantage of the unlimited profit potential.

For short Strangles and Straddles, I tend to look to take profits when I can close them for 50% of the premium I collected in a Strangle, or 75% of the higher premium I collected for the Straddle. I don’t want to get too greedy with these short gamma plays, as that can come back and bite me quickly.