A strangle is a strategy that consists of buying both a put and a call option on the same stock with different strikes.
The stock should stay near the strike price until expiration, at which point both options would be worthless.
A trader can either close out all positions before expiry or roll forward by simultaneously selling an in-the-money put and buying an out-of-the-money call of the same underlying asset.
You can utilize this strategy to speculate upward or downward movements of the underlying asset’s price. However, this may not necessarily work for you, not even if you’re the best forex broker in Hong Kong.
The premium generated from writing puts and calls represents most traders’ primary revenue source when trading strangles. When deciding how many contracts to write, one must balance their perceived risk versus the potential return.
There are several strategies to use when considering whether it is the right time to buy or sell strangles. Below are some of these strategies:
Volume analysis
One of the most popular ways traders determine when the right time is to enter into a trade is through volume analysis. Volume refers to the number of contracts traded during a specific period (generally in 1 minute, 5 minutes, 15 minutes, etc.).
To understand which direction price movement will take, one has to determine how many options were bought and sold within a timeframe.
You can use several moving averages for this kind of analysis, including the 20-day exponential moving average (EMA), 50-day EMA, 100-day EMA and 200-day EMA.
Sentiment analysis
Sentiment analysis is a market analysis that uses social media to measure trader opinion on a specific asset or commodity.
In the case of strangles, participants in this sentiment analysis would most likely be active options traders who may post their opinion regarding overall sentiment for an underlying stock they are trading on a forum such as Reddit’s popular “wall street bets” section.
You can also find sentiment data from financial news websites such as Seeking Alpha and Benzinga. Their articles often contain opinions from professional investors and traders concerning whether now is a good time to buy or sell particular stocks.
Option volume at price
It is vital for traders always to be aware of price activity when they are trading.
Option volume at a price is an option-trading strategy that uses the dollar amount of contracts traded (in each row) at a specific stock price to determine whether or not it is the right time to buy or sell strangles.
If there was a large number of option contracts bought in one row for a particular stock, this means there is more demand in the market, and therefore options prices will likely rise for buyers to meet sellers’ asking prices.
On the other hand, if numerous put or call options were sold during a specific period, traders can assume that either supply outweighs demand or that the market expects a downward movement in the price for this particular stock.
Time decay
The passage of time affects options differently regarding option buyers and option writers. For example, time decay works in an options buyer’s favour because all other factors being equal, an option will lose its value as time passes.
Less and less of the commodity (in this case, a stock) is available for purchase or sold at the strike price during expiry. For most out-of-the-money put options, they will most likely expire worthless if bought when strangle is first initiated.
The chances of a sudden rally are lower since underlying asset’s prices tend to trend downwards more often than upwards during market corrections or bear markets.
Bottom line
As you can see, traders should consider several factors when determining whether it is the right time to buy or sell strangles.
It would be best to always keep in mind that buying or selling too much of an options contract at one time will lower your capital, so only risk what you are willing to lose.
When deciding how many contracts to write, one must balance their perceived risk versus the potential return.
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