Straddles vs. Strangles - Which Options Strategy Should You Use & When?

hey what's up everyone this is Kirk here again at option alpha and tonight we are going to talk about the difference between using straddles versus strangles we're gonna do something a little bit different here because I like to draw and I like to use some of these like little whiteboards or papers that we're gonna do so in today's talk obviously the different two strategies that we're gonna look at we're gonna do both kind of looking at the payoff diagram for each of these and then also just kind of how you use each of these different strategies because a lot of people have questions on how to use them when's the best time the whole deal so we'll get into that here in a second so what we want to do first is talk about straddles first and straddles are probably one of the simpler options strategies to understand because it's basically just selling and at the money call and an app the money put so your payoff diagram looks like this if you're gonna do a short straddle you would sell the same short strike put and call so you would be like in this case you would sell the 50 strike put and the 50 strike call now the beautiful thing about doing a straddle is you collect a lot of premium because those options are worth a lot of money so by doing the straddle and by selling those for a lot of money that also moves out the break-even point which is why you have this kind of pyramid shape here so you might sell a straddle for let's say three hundred and fifty dollars when it's doing the at the money options now a strangle on the other hand is selling an option that's out of the money on either end so you'll be selling it out of the money put and then selling it out of the money call option and you're going a little bit further out and you generally have much wider breakeven points generally speaking but because you're going further out you collect less money so this option again if the stock is trading at let's say $50 you might sell the 35 strike put and the 65 strike call or something like that right so you would go a little bit further out on either end and in exchange for going further out and potentially having a higher probability of success you might then collect less money so let's say that this strangle here collects I don't know let's say just a dollar to use round numbers right so it could be different for different stocks but the whole idea here is that when you do a straddle you're gonna go at the money really aggressive try to maximize the premium that you've collected and when you do a strangle you're gonna go a little bit further out and you're gonna collect less money but you're gonna have potentially a little bit higher chance of success okay so those are the two main strategies there and I can barely see the screen on my end because I'm writing on this thing so if you guys have questions as you're joined in here please let me know in the comments section or definitely if you want to see other strategies or techniques now the way that we generally use these option strategies just so you can see how it kind of looks with the stock chart but let's say that you know we have a stock that's just moving right and all we would want to do with the stock is to bracket it in some sort of profitable range right so that's what's different about options trading at least the way that we do is that I don't care necessarily if the stock continues to go higher or from this point goes lower or sideways like it doesn't matter at this point with a straddle or strangle because your breakeven points are out here much further than where the stock is trading at the moment and so all we're trying to do here at this point is just take advantage of the fact that the stock could potentially trade inside of a 70 or 80% probability zone right so that's what we do we'd sell a call option up here if we're doing a strangle right or sell a put option down here and by doing this again you give yourself a 70% 80% whatever you want to build you build out whatever probability of success level you want to get to by selling these options right so that's the whole idea with doing this type of strategies you're basically forcing the market to make an extended move in one direction or another that it won't generally make over time right and if it doesn't then we keep that premium 70 percent of the time or more right we've actually found in most of our back testing that we keep that premium much more than 70% of the time so when would you want to use a strangle or a struggle I guess that's the question that most people have all the time is what are the best times to use these types of strategies well here's what we basically say right we basically say that when there is lower volatility or IVR as we define it when there's lower IVR you generally want to go with the strangle and the reason you want to do that is because you just don't want to be super super aggressive selling premium you can go with the strangle you can go a little bit further out you want to maximize your probability of success and in exchange you're gonna give up a little bit of the premium that you could collect but that's okay when there's higher IVR or higher implied volatility rank in the market higher implied volatility across the board then what you want to do is you want to go ahead and choose the straddle so you want to go a little bit more aggressive with your type of trading strategy so that if the market does see that quick drop in implied volatility then your potential premium is going to realize itself much quicker now people have an issue with the straddle because you're selling at the money options they think oh that's too risky or you're selling an option and it's ones in the money in all the time and could be assigned but again go back to some of the other videos that we've done assignment doesn't really happen most the time until the week of expiration so yes you can technically be assigned at any time but you're collecting a lot of money up front and you're gonna try to maximize that that time basically or that potential profit much sooner so you're gonna capture that profit sooner or get out of the trade sooner manage it sooner whatever you want to call it a little bit faster so you collect more but you also get more upfront right now what other people always have questions on and this is one more thing before we end up here tonight is how do I convert these strategies if I'm not in an account that can trade an undefined risk position right so many of you might even have that question like what do I do if I'm trading if I want to trade a straddle or I want to trade a strangle but I'm in a account that has an undefined or that doesn't allow margin this allowed me to do that so here's what we're gonna do and I'm gonna try to draw this on this top half here because I'm running out of paper my daughter keeps stealing paper from me but here's what you would want to do if you are trading the strangle if that's the basis of your position and if you're trading in an IRA or risk to find account all you want to do is you want to go really far out on either end and you want to buy these wings and create what's called an Iron Butterfly so again all you want to do is you want to go really far out and you want to buy cheap options out of the money so you'd buy a cheap call and you buy a cheap put option out of the money and create what's called an Iron Butterfly so it looks like a butterfly position but it's an iron butterfly because you're basically selling a spread on either side same thing with the actual strangle itself right so when you go ahead and do the original strangle and you're doing it undefined risk you're just gonna sell a call option above the market and a put option below the market when you want to convert this you're gonna convert it into an iron Condor by buying a cheaper put option below your short strike and then on the top side you're gonna buy a cheaper call option above your original call short strike right so creates this iron butterfly position now in both cases you're gonna sacrifice a little bit of premium to do this right for sure but again you can't trade an undefined or a strategy in your account so you've got to you know basically make do with what you have right so sacrifice a little bit of premium for the sake of basically giving yourself a position that has defined risk right so you know exactly how much you can make you know exactly how much you can lose etc so if you guys enjoy these videos please let me know I love it and definitely want to get some thumbs up on here let me know what other strategies you want to go through I think this is cool I enjoyed doing this on this kind of chart I realized next time I need to have much more paper available to kind of draw on and use but again if you guys are watching these videos if you'd give a thumbs up or share a comment I love to know what you guys think and well I definitely do more of these here in the future so thanks Sam for joining in thanks everybody for joining in and we'll talk to you guys soon have a great night [Music] you

Channel: Option Alpha

Views: 152,314

Rating: 4.9315734 out of 5

Keywords: stock market, options trading, options, option strategies, trader, financial education, trading, options trading tutorial, strangle option strategy, options trading strategies, how to trade options, stock trading, selling options, strangle, investing

Id: p1zZOZgMhag

Length: 8min 56sec (536 seconds)

Published: Fri Nov 24 2017