When should I use a straddle versus a strangle, and how do I calculate the breakeven points?
CFA Level I covers both straddles and strangles as volatility strategies. Both seem to profit from big moves in either direction, but strangles are cheaper. When would I pick one over the other, and how do I figure out how big the move needs to be to profit?
Straddles and strangles are the quintessential volatility strategies. Both bet on a large price move, but they have different risk/reward profiles and cost structures.
Long Straddle:
- Buy 1 call at strike K
- Buy 1 put at strike K (same strike, same expiration)
- Both options are typically ATM (at-the-money)
Long Strangle:
- Buy 1 call at K_2 (OTM, above current price)
- Buy 1 put at K_1 (OTM, below current price)
- Both options are out-of-the-money
Side-by-Side Comparison:
| Feature | Long Straddle | Long Strangle |
|---|---|---|
| Cost | Higher (ATM options are expensive) | Lower (OTM options are cheaper) |
| Max loss | Total premium (both premiums) | Total premium (both premiums) |
| Breakeven range | Narrower | Wider |
| Required move to profit | Smaller | Larger |
| Profit potential | Unlimited in both directions | Unlimited in both directions |
Straddle Example:
Nexus Aerospace trades at $200.
- Buy $200 call at $8.50
- Buy $200 put at $7.80
- Total cost: $16.30
Breakeven points:
- Upper: $200 + $16.30 = $216.30 (stock must rise 8.2%)
- Lower: $200 - $16.30 = $183.70 (stock must fall 8.2%)
Strangle Example:
Same stock at $200.
- Buy $210 call at $4.20
- Buy $190 put at $3.60
- Total cost: $7.80
Breakeven points:
- Upper: $210 + $7.80 = $217.80 (stock must rise 8.9%)
- Lower: $190 - $7.80 = $182.20 (stock must fall 8.9%)
Decision Framework:
| Choose Straddle When | Choose Strangle When |
|---|---|
| You expect a large move near the current price | You want cheaper premium outlay |
| You're confident the move will exceed the premium | You're less certain about magnitude |
| You want to maximize dollar profit per unit move | You want to limit risk |
| Before earnings/events with high stakes | When IV is already elevated |
Important Nuance — Implied Volatility:
Both strategies are long vega (benefit from rising IV). This matters because:
- Before earnings: IV is elevated, making both strategies expensive
- If the stock moves but IV collapses (post-earnings), you can lose money even with a correct directional bet
- The stock needs to move more than the market expects (more than what's priced into IV)
Exam Tip: Calculate breakeven points for both strategies. Know that straddle breakevens are strike plus/minus total premium, while strangle breakevens are upper strike plus call premium and lower strike minus put premium. The exam often asks for profit at a specific stock price.
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