Strangles are most often used in situations where the trader expects a substantial price move, but is unsure of the direction. Strangles are ideal for trading around upcoming events, such as earnings announcements, CEO interviews, product demonstrations and so on.
Trading with a Strangle
While all strangle strategies have the same basic principle of a put and call with the same expiry date, there are no hard rules for how a strangle trade is constructed.
However, due to the fact that the trader is paying two premiums and only one or less of the options is likely to pay off, strangle trades tend to involve deep out of the money options that have low premiums and large payoffs in the case of substantial price moves.
This makes strangles ideal for rarer and more extreme events, as opposed to establishing strangle trades for minor events that are unlikely to lead to a major price move in either direction.
In the above order window you can see that we are looking to open a long strangle (buying call and puts) on SYY. Our max loss is the premium we pay to open the position which is $1,290 with our max profit being infinity because theoretically the stock could go up forever (but we know that is highly unlikely).
Strangle trading strategies are ideal for day traders, many of whom make short term directional trades before major events.
While it is better to be able to correctly foresee the direction of the price move, being able to purchase low premium options for events with uncertain outcomes provides day traders with yet more opportunities to create profits.
Newer day traders should beware of the temptation to overuse the strangle strategy as a form of insurance, as the cost from a failed trade is doubled and the two premiums reduce the profits from any successful trades.
Traders should be attempting to foresee the direction of the price movement whenever possible, and only rely on strangle trades in situations where the uncertainty is balanced by the potential for substantial price moves.