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STRANGLES

STRANGLES. Cruz. Dela Cruz. Lim. Lopez. What is a STRANGLE?. CALL. PUT. SAME EXPIRATION DATE. DIFFERENT STRIKE PRICE. What is a STRANGLE?. A tool for SPECULATION Two types:. LONG Bottom Vertical Combination. SHORT Top Vertical Combination. LONG CALL + LONG PUT. SHORT CALL +

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STRANGLES

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  1. STRANGLES Cruz. Dela Cruz. Lim. Lopez.

  2. What is a STRANGLE? CALL PUT SAME EXPIRATION DATE DIFFERENT STRIKE PRICE

  3. What is a STRANGLE? • A tool for SPECULATION • Two types: LONG Bottom Vertical Combination SHORT Top Vertical Combination LONG CALL + LONG PUT SHORT CALL + SHORT PUT

  4. Example • Let K1 = strike price of the put K2 = strike price of the call c = call premium p = put premium *Where K1 < K2

  5. LONG STRANGLE Given: K1 = 40 (put) K2 = 60 (call) c = 3 p = 5 Long Call Long Put

  6. LONG STRANGLE Given: K1 = 40 (put) K2 = 60 (call) c = 3 p = 5 If S = 50, PC = -3 PP = -5 PS = -8 If S = 80, PC = 17 PP = -5 PS = 12 Long Call Long Put

  7. LONG STRANGLE • Gain: unlimited • Loss: limited to the premiums paid • Investor’s assumption: Large price movement in either direction • Effect on value: Volatility = direct

  8. SHORT STRANGLE Given: K1 = 40 K2 = 60 c = 3 p = 5 Short Put Short Call

  9. SHORT STRANGLE Given: K1 = 40 K2 = 60 c = 3 p = 5 Short Put Short Call 80 50 If S = 50, PC = 3 PP = 5 PS = 8 If S = 80, PC = -17 PP = 5 PS = -12

  10. SHORT STRANGLE • Gain: limited to the premiums received • Loss: unlimited • Investor’s assumption: Large stock price movements are unlikely • Effects on value: Volatility = inverse

  11. LONG vs. SHORT LONG • Assumes HIGH VOLATILITY of prices • Limited loss, unlimited gain • For UNCERTAINTY • Less risky SHORT • Assumes LOW VOLATILITY of prices • Unlimited loss, limited gain • For STABILITY • More risky

  12. Advantages • Neutral or non-directional strategy • Unlimited profit if price continues to move in one direction • Loss is limited to the premiums paid (bottom vertical) • No need to buy the underlying asset

  13. Disadvantages • More commissions than just buying a call or a put option (broker fees) • Lose more money if stock price stays stagnant (long strangle) • Unlimited Loss (short strangle)

  14. FIN.

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