Straddle vs. strangle

Straddles and strangles may appear to be superficially equivalent options strategies, but an example from yesterday highlights some of their key differences—and why traders need to understand them.

On Monday, Palo Alto Network’s (PANW) implied volatility (IV) was below its historical volatility (HV), and it appeared on the LiveAction scan for symbols with 52-week low IV. On Tuesday, its “volatility constellation” showed that IV was also below the 30-day average for the next few expirations, including the March monthly options (“Mar23”):

Because options with lower IV tend to be cheaper than those with higher IV, the PANW options market could have been seen as a relatively favorable environment for options buyers. Since jumping more than 12% on January 22 after its latest earnings release, PANW has mostly moved sideways. Early Tuesday morning it was trading around $188:

Traders who thought PANW would soon make another move but were uncertain about its direction may have thought about using a non-directional strategy like a straddle or strangle. While a basic long straddle consists of buying an at-the-money (ATM) call and ATM put with the same expiration date, a basic long strangle pairs an out-of-the-money call and an out-of-the-money put with strike prices roughly the same distance from (above and below) the current stock price.

Long straddles and strangles have similar objectives—both can profit if the stock moves higher or lower, as long as it moves enough to offset the cost of the options—but they have practical differences. For example, yesterday morning when PANW was trading around $188, an ATM straddle in the March monthly options (long the March $187.50 call and put) was priced at $8.85. At the same time, a long strangle pairing a March $192.50 call and a March $182.50 put was trading at $4.71. That’s the first difference: Strangles are usually cheaper than straddles.

In terms of potential profitability, the breakeven prices for a straddle at expiration are the strike price plus and minus the cost of the position—in this case, $187.50 +/- $8.85, or $196.35 and $178.65 (represented by the thick dashed lines on the price chart). The breakeven prices for a strangle are the upper strike price plus the cost of the position ($192.5 + $4.71 = $197.21), and the lower strike price minus the cost of the options ($182.50 –  $4.71 = $177.79)—the thin dashed lines on the price chart.

That’s the second major difference: Long strangles usually require the stock to make a bigger move to achieve profitability. While the difference in this example is relatively small, it is often much larger  depending on the strike prices a trader uses, as well as the amount of time until expiration.

Strangle vs. straddle—lower cost of entry vs. higher barrier to profitability. Options have many moving parts, and depending on the situation, different strategies can be used to achieve similar goals. Understanding the practical differences between related positions can help traders choose those that best reflect their risk levels and trading goals.

Market Mover Update: Fed chief Jerome Powell’s Senate testimony on Tuesday—during which the Fed Chairman reminded everyone that interest rates were going higher than previously thought, and that individual increases could be bigger than 0.25%¹—was met by a swift drop into negative territory by the S&P 500 (SPX). The Cboe Volatility Index (VIX) had thrown up a potential red flag on Monday, though: Despite the S&P 500’s higher close, the VIX also closed higher, signaling heightened concerns about volatility.

Today’s numbers include (all times ET): Mortgage applications (7 a.m.), ADP Employment Report (8:15 a.m.), International Trade in Goods and Services (8:30 a.m.), Jerome Powell congressional testimony, day 2 (10 a.m.), Job Openings and Labor Turnover Survey (10 a.m.), EIA Petroleum Status Report (10:30 a.m.), Beige Book (2 p.m.).

Today’s earnings include: Campbell Soup (CPB), United Natural Foods (UNFI), Korn Ferry (KFY).

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¹ Reuters. Fed's Powell opens door to higher and possibly faster rate increases. 3/7/23.