Factors That Affect Strangle Prices
Keywords: options trading, options trading strategies, stock options trading, stock trading1
Since the Strangles’ profit potential is dependent on its price from purchase time to expiration, the investor should be aware of the several factors that affect the Strangles’ price.
Stock Price
The first is, of course, stock price. The stock’s price will dictate the value of both components of the Strangle - the call and put thus affecting the Strangle price as a whole. As the stock price moves, the prices of the call and the put will fluctuate via the current Deltas of the options and thereby affect the price of the Strangle.
As the stock moves higher, the price of the call will increase while the price of the put will decrease. However, they do not move linearly meaning that as the stock continues higher, the call’s value increases progressively more while the put’s value decreases progressively less. The option’s changing Delta causes this non-linear effect.
The call Delta increases as the stock goes up while the put Delta decreases as the stock goes up. This opposing effect continues until finally the call gains value dollar for dollar with the stock (once its Delta reaches 100) indefinitely. At the same time, the put value-loss stops because the put now has no value (as put Delta approaches 0). Of course, the opposite is true if the stock trades down.
The call will lose value progressively slower until it reaches $0 while the put will gain value at an increasing rate until the Delta becomes 100 and then the put will gain dollar for dollar with the stock indefinitely. The effect of stock movement on the dollar value and Delta value of the Strangle is in the chart below.
Again, we will use the July 60/65 Strangle as an example. The Strangle will be worth $3.31 ($2.11 for the call, $1.20 for the put). For clarification, these prices are not expiration prices. This Strangle has three weeks to go before expiration.
Stock $ Call $ Call Delta Put $ Put Delta Strangle $
55.50 .23 7 5.23 -76 5.46
57.50 .42 15 3.86 -62 4.28
59.50 .78 24 2.74 -50 3.52
61.50 1.35 34 1.85 -38 3.20
63.50 2.11 45 1.20 -28 3.31
65.50 3.13 56 .74 -19 3.87
67.50 4.35 66 .44 -13 4.79
69.50 5.77 75 .25 -08 6.2
Implied Volatility
A second factor that affects the pricing of a Strangle is implied volatility. As implied volatility increases, the value of the Strangle increases. As stated, the price of both calls and puts increase as implied volatility increases.
A Strangle will feel an increased effect when volatility increases because the strategy employs two options working together and not against each other. When a strategy uses two options working against each other, the effect of implied volatility on the strategy is the difference of its effect on each option. This is different from a Strangle. With a Strangle, the two options are working together combining the effect of implied volatility on each option.
Implied volatility movement affects an individual option to an exact dollar amount as indicated by the option’s volatility sensitivity component or Vega. An option with a $.05 Vega will increase five cents in value for every tick that implied volatility increases and likewise will decrease in value five cents for every tick that implied volatility decreases.
Because the Strangle combines a call and a put, the Vega value of the call adds to the Vega value of the put. This means that the Vega of a Straddle is the sum of the Vega of the call plus the Vega of the put.
Look back at our example. If the July 65 call has a .10 Vega and the July 60 put has a .07 Vega then the July 60/65 Strangle will have a .17 Vega. This means that for every tick that implied volatility increases, the July 60/65 Strangle will increase $.15 in value.
Conversely, for every tick that volatility decreases, the July 60/65 Strangle will decrease in value. The chart below shows how the Strangles’ value changes at different implied volatility levels.
Stock Price Vol. Level Call $ Put $ Strangle $ Strangle Vega
63.50 30 2.11 1.20 3.31 .168
63.50 40 3.02 1.97 4.99 .173
63.50 50 2.92 2.80 6.72 .174
63.50 60 4.83 3.63 8.46 .174
63.50 70 5.73 4.46 10.19 .174
When you study the chart, you can see that as implied volatility increases or decreases the value of the Strangle increases or decreases by the amount of the Strangles’ Vega multiplied by the amount of tick change in implied volatility.
Time
Finally, time is another major factor affecting the price of a Strangle. As you have learned from our previous strategies, time takes a toll on all options. Its effect is even more pronounced on this strategy that combines two options for the same time period.
A Strangle will see a much higher rate of decay than a single option. From previous discussions, we should be familiar with the option decay chart and its non-linear curve. As time goes by, the Strangle will decay, day after day, at an ever-increasing rate until expiration Friday at 4:00 p.m. The implication to the buyer and seller should be obvious.
The passage of time decreases the value of the Strangle and thus always favors the seller. Time works against the buyer. The buyer has only until expiration to get either a large stock or implied volatility movement to offset the price paid for the Strangle.
Ron Ianieri is currently Chief Options Strategist at The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk. For more information please contact The Options University at www.optionsuniversity.com or 866-561-8227
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