Straddle, strangle and butterfly strategies each offer very interesting risk/profit

profiles and various outcome possibilities. If you know some of the option

trading fundamentals, market dynamics and technical parameters about options

(such as greeks, time decay, volatility etc.) it might be beneficial to acquire

knowledge about some of the more advanced strategies out there and the

opportunities they may offer.

### Straddles

Straddle is a non-directional option strategy that can

be created by simultaneously buying a call and a put option on the same

underlying security, with the same strike price and the same maturity date.

Straddle is a very interesting strategy that will only

be profitable if the underlying price goes up or down more than the cost of the

strategy. Cost of the strategy can be calculated by the cost of each option

premium that’s required to create the strategy.

You can also see from the graph that upside of this

strategy is theoretically limitless.

#### Example:

Let’s say Uber stock is trading at $35 in January. An

options trader enters a long straddle strategy. The strategy can be constructed

by buying put options and call options both with strike price of $35. Let’s say

options also have an expiry date in 2 months in March and cost $200 each. Total

strategy cost is $400.

·

At the expiration date, if the stock is up and trading at $45,

put will expire out of the money and will be valueless. Call option, however,

will be worth (45 – 35) x 100 = $ 1000.

Total profit is 1000 – 400 = $600.

·

At the expiration date, if the stock is down and trading at $25,

call will expire out of the money and will be valueless. Put option, however,

will be worth (35 – 25) x 100 = $ 1000.

Again, total profit is 1000 – 400 = $600.

·

Here is the worst scenario for the strategy. At the

expiration date, if the stock is perfectly sideways and still trading at $35,

call will expire out of the money and will be valueless. Put option will also

expire worthless.

Total loss will be the cost of the strategy: $400

·

On the other hand, we can calculate the breakeven points for

the strategy to turn profitable. Simply $400 profit is needed to counter for

the cost that was needed to enter the strategy.

With an option multiplier of x100, $400 can be made

with 400/100 = $4 difference in either direction.

So, if the underlying stock rises to $39 or drops to

$31, this strategy will be at breakeven (no loss, no profit) and anywhere

outside that range of $31 – $39 this straddle strategy will start to be a

profitable strategy.

From this example, as you can tell, straddle is not a

strategy that likes a flat market, but it thrives when there is enough movement

on either direction.

### Strangles

Strangle is a strategy that resembles straddle with a tiny difference. Instead of maximum loss being a unique value, in a strangle strategy maximum loss happens through a range of underlying security prices.

How is this different behavior achieved? Simple. While straddle is constructed by buying a call and put option with the same strike price, strangle is created by buying call and put options with different prices that allow this behavior.

Let’s see an example to make it clearer.

#### Example:

Let’s say Uber stock is trading at $35 in January. An

options trader enters a long strangle strategy. The strategy can be constructed

by buying call options with a strike price of $40 and put options with a strike

price of $30. Let’s say options also have an expiry date in 2 months in March

and cost $75 each. Total strategy cost is $150.

·

At the expiration date, if the stock is up and trading at $45,

put will expire out of the money and will be valueless. Call option, however,

will be worth (45 – 40) x 100 = $ 500.

Total profit is 500 – 150 = $350.

·

At the expiration date, if the stock is down and trading at $25,

call will expire out of the money and will be valueless. Put option, however,

will be worth (35 – 30) x 100 = $ 500.

Again, total profit is 500 – 150 = $350.

·

Here is the worst scenario for the strategy. At the

expiration date, if the stock is perfectly sideways and still trading at $35,

call will expire out of the money and will be valueless. Put option will also

expire worthless.

Total loss will be the cost of the strategy: $150

From this example as you can tell strangle is very

similar to straddle and is not a strategy that likes a flat market, but it

thrives when there is enough movement on either direction. It is created with

using call and put options with two different strike prices. Its downside is

less than a similar straddle strategy however, the range of the downside is

wider.

### Butterflies

Butterfly may look like the inverse version of

straddle strategy on the graph, however there is a significant difference:

limited downside. It’s different than straddle’s limitless upside which is an

advantage as limitless downside strategies can be very difficult to manage and

very costly when market view turns out wrong.

Unlike straddle and strangle butterfly is a strategy

that thrives in flat market and doesn’t like directional movement on both

sides. Fortunately, though, maximum loss will flat out at a certain value on

both directions.

Let’s see an example to make things clearer:

### EXAMPLE:

Let’s say Uber stock is trading at $35 in January. An options trader

enters a long butterfly strategy. The strategy can be constructed by writing 2

call options with a strike price of $35 and buying 2 call options with strike prices

of $30 and $40.

Basically, we can say that butterfly strategy is created by buying a call

spread and selling appropriate amount of at the money call options.

Hypothetically let’s say 2 calls written and sold at the money were $3

each and investor collected a total of $300 + $300 = $600 premium with an

option multiplier of 100x. Also let’s say call with a strike price of $30 was

$7 and call with the strike price of $40 was $1. So, the total cost at the

entry for the strategy is: $600 – ($700+$100) = $200 total.

- At the expiration date, if the stock is still $35, the strategy will be

profitable. Calls that were at the money will expire worthless and call with

the strike price of $40 will expire worthless. Call option with strike price of

$30 will be worth $35 – $30 = $5 x 100 = $500 minus your cost for the

strategy’s net premium: – $200

$500 – $200 = $300.

- At the expiration date, if the stock price falls below $30 or rise above $40 the

strategy will recur maximum loss which is the cost to enter the position: $200

From this example as we can tell butterfly is a strategy that likes a flat

market, but it doesn’t do well when there is a significant movement in either

direction.