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Strangle

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A strangle is an advanced options strategy that requires the investor to be long both an out-of-the-money call and an out-of-the-money put. To properly execute the strangle, the investor must buy a call and put with same expiration date, but with different strike prices. A strangle tends to be used by an investor that thinks a stock will move significantly but is unsure as to which direction. For example, if a drug company is set to disclose whether the FDA approved or disapproved their new miracle drug, an investor may employ a strangle in anticipation of the stock price trading sharply higher on approval or plunging lower on disapproval.

For example, an investor who wants to trade a strangle on ABC Inc. when that stock is trading at $45 in May might opt to buy a June 50 call and a June 40 put. To set up this strangle, the trader may purchase the call for $5 ($5 x 100 shares=$500) and the puts for $2 ($2 x 100 shares=$200). That brings the cost of the strangle to $700. For the strangle to become profitable, ABC must move significantly out of the $40-$50 range. For example, if ABC moved to $60, the $50 calls would be worth $10 and the trader could sell his contracts for $1,000, covering the $700 cost of the strangle and netting a $300 profit. On the downside, ABC would need to drop to at least $33 for the strangle to break-even. The above example does not take into account the commissions required to execute the strangle.



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