Long-Strangle Example
Let’s return to Susan, who earlier in this chapter bought a straddle on Acme
Brokerage Co. (ABC). Acme currently trades at $74.80 a share with current
realized volatility at 36 percent. The stock’s volatility range for the past
month was between 36 and 47. The implied volatility of the four-week
options is 36 percent. The range over the past month for the IV of the front
month has been between 34 and 55.
As in the long-straddle example earlier in this chapter, there is a great deal
of uncertainty in brokerage stocks revolving around interest rates, credit-
default problems, and other economic issues. An FOMC meeting is
expected in about one week’s time about whose possible actions analysts’
estimates vary greatly, from a cut of 50 basis points to no cut at all. Add a
pending earnings release to the docket, and Susan thinks Acme may move
quite a bit.
In this case, however, instead of buying the 75-strike straddle, Susan pays
2.35 for 20 one-month 70–80 strangles. Exhibit 15.9 compares the greeks of
the long ATM straddle with those of the long strangle.
EXHIBIT 15.9 Long straddle versus long strangle.
The cost of the strangle, at 2.35, is about 40 percent of the cost of the
straddle. Of course, with two long options in each trade, both have positive
gamma and vega and negative theta, but the exposure to each metric is less
with the strangle. Assuming the same stock-price action, a strangle would