"It can go up or it can go down." That's a phrase you'll often hear from market commentators who are undecided about the overall market direction. While conventional crypto traders might find these kinds of comments pointless, crypto options traders will beg to differ. This is thanks to their knowledge of the strangle options strategy. With it, experienced crypto options traders can make use of their knowledge of implied volatility and make a calculated trade on the underlying asset moving more than what's expected.
Keen to learn more about this options strategy that can help you to make gains, regardless of movement in either direction? Here, we'll explain how to set up a strangle and explore the benefits and risks associated with executing the strangle option strategy.
What is a strangle option strategy?
A strangle is a bidirectional options strategy that involves the buying of both call and put options for the same asset with the same expiration date, but different strike prices. Since calls and puts are involved, the strangle option strategy will benefit the trader as long as there's a significant enough movement in the asset's price.
Why are strangle options so popular among traders?
A key characteristic of strangles is that they cover both fields — regardless of whether the digital asset's price appreciates or depreciates. This ultimately makes the strangle option strategy a favorite among crypto options traders who keep abreast of the latest market happenings and are aware that prices are about to get volatile. Since they're expecting a large price movement for the underlying cryptocurrency but aren't sure whether it'll be higher or lower, they can choose to play both fields by buying or selling both calls and puts. This allows undecided crypto options traders to make money on either side of the forecasted move while limiting their overall risk.
Understanding implied volatility
Before further exploring the benefits and risks of trading strangle options, it's key to first understand that strangles are volatility-based options strategies. In other words, they only thrive during instances of high implied volatility (IV). As a determining factor that accounts for the amount of uncertainty within the market, IV measures the expected price movements in an options contract. Each contract has its own unique IV, which fluctuates over the lifespan of the option and is largely determined by the trading activity of crypto options buyers and sellers.
For reference, the IV of an options contract tends to be higher right before an upcoming catalyst is about to happen. This could range from a major blockchain network upgrade to a huge macroeconomic announcement regarding inflation from the United States Federal Reserve. Given that strangles are closely tied to volatility, it's crucial for crypto options traders to first understand IV before diving headfirst into executing strangle options strategies.
Perks of trading strangle options
Minimizing exposure to directional risk
The most significant advantage of using a strangle options trading strategy is the fact that it allows you to make gains regardless of whether the crypto asset's price goes up or down — the move just has to be significant. This can be extremely helpful if you're still in a dilemma about your directional bias after conducting the necessary due diligence and market research and want to protect yourself against directional risk.
Low capital intensity
Another benefit is that strangle options are significantly more affordable than most crypto options strategies. This is because out-of-the-money (OTM) options contracts tend to have lower premiums than their in-the-money (ITM) counterparts due to their lack of intrinsic value. This allows veteran strangle options traders to leverage themselves sufficiently to make their measured speculative trade.
Risks of trading strangle options
Highly dependent on volatility and catalysts
Since strangles involve OTM calls and puts, they're less likely to provide gains since the options strategy will require a huge movement in either direction for options traders to even come close to breaking even. That's why crypto traders who execute strangles must have advanced knowledge about market timing to take advantage of an upcoming catalyst or major news event.
Not a beginner-friendly options strategy
Unlike other options strategies that involve trading options with some form of intrinsic value, strangles deal exclusively with OTM options. This means they're highly prone to theta decay over time. That's why beginner options traders could lose almost all of their premiums overnight if they aren't careful when it comes to deciding the right strike prices and expiry dates
Types of strangle options
There are two types of strangle strategies in options trading:
Long strangles which involve buying a call and a put at OTM strike prices
Short strangles which involve selling a call and a put at OTM strike prices
Long strangles are the more popular strategy of the two as they typically involve less risk. Let's first go through how long strangles work before explaining the mechanics of short strangles. For both of the examples below, we'll be referring to BTC prices of about $34,000 and for the call and put contracts to have expiry dates of 24 November, 2023.
Long strangle example
To execute a long strangle, a trader must purchase a call and a put option, at the same time. Both would be OTM, while the call’s strike price would be higher than the cryptocurrency’s current market price. The put’s strike price would, as expected, be lower than the coin or token’s current market price. The premium paid for both contracts represents the trade’s risk.With this set-up, the upside-profit potential is extremely high (in theory) if the cryptocurrency experiences an upward surge in price. However, growth potential also exists if the coin or token’s price falls.
For our long strangle example, with the assumption of BTC at about $34,000, if we're expecting a huge move in Bitcoin's price in either direction, it'll likely have to do with the approval of the Bitcoin spot ETF. To play on the volatility of this major news story, crypto option traders could purchase both the $30,000 BTC put and $37,000 BTC call. This will account for a 10% swing in either direction and will cost about $1,320 in total premiums.
By executing this long strangle option strategy, crypto options traders are hoping that the news of the Bitcoin spot ETF approval (or delay) will cause a spike in BTC prices and cause their OTM options to become ITM thanks to price fluctuations.
Short strangle example
Similarly, a crypto trader looking to execute a short strangle would sell puts and calls, at the same time, both of which are OTM. Unlike a long strangle, however, is the reduced potential for growth — requiring the cryptocurrency to trade in a relatively tight range, as the maximum earnings are equal to the premium paid by the contracts’ buyer.
For the short strangle example, assuming BTC is currently at about $34,000, if we believe that BTC prices will stagnate until late November 2023, it would make sense to execute a short strangle instead. In the case of the Bitcoin spot ETF decision, it could be delayed down the line or held up by some legislative bureaucracy. This could ultimately cause BTC prices to trade in a range until further development of the Bitcoin spot ETF story. To make a play off this lack of volatility, crypto options traders could follow suit with the example above and write both the $37,000 BTC call and $30,000 BTC put contracts to collect about $1,320 in credited option premiums. Similarly, this also accounts for a 10% swing from the current $34,000 price of BTC.
In writing these contracts and performing a short strangle options strategy, crypto options traders are risking unlimited losses should Bitcoin rally and exceed the intended range of prices. That's where it's necessary for these crypto traders to perform their required due diligence in deciding whether it's worth it from a risk-reward analysis to collect $1,320 in premiums and face the risk of blowing up their trading account.
Strangle vs. straddle — which is the better option strategy?
Both strangles and straddles are options strategies that allow crypto traders undecided on the direction of a cryptocurrency’s next move to make gains on a large swing in either direction. However, a key difference lies in how each strategy is executed. While the strike prices of call and put contracts of strangle options strategies are OTM and different, straddles feature call and put contracts with the same strike price.
As straddle options strategies involve purchasing at-the-money calls and puts, they typically cost more to execute than strangles. Additionally, when comparing strangles with straddles, it's often noted how straddle options strategies carry less risk than their strangle counterparts since they require a smaller price move to achieve growth.
Ultimately, it comes down to personal preference and capital availability. If you're limited on capital and have a higher risk tolerance, strangles are the ideal options strategy. Conversely, straddles have increased chances of growth and work as an effective low-risk options strategy.
Final words and next steps
Where there's volatility, there'll likely be trades to be made. That's where volatility-based options strategies like strangles come into play and have become so popular among crypto options traders. Whether you're someone who rides the wave or writes the contracts for said wave riders, it's best to first understand the benefits and risks of strangles before executing them. From exploring volatility as a concept to highlighting specific use cases of long and short strangles, we hope our guide to strangle options has helped in adding another tool to your crypto options strategy arsenal.
Keen on expanding your options strategy toolset? Check out our in-depth guides to covered calls and crypto collar options for more information on hedging your portfolio against upcoming volatility and catalysts.