Question

Why with 'long strangle', the loss is decreased if price remains unchanged, compared with 'long straddle'?

Why the loss sustained by investors would be the double premium ( long strangle) which is same as the loss ( long straddle) equal to double premium.

Market price of asset Premium- LOSS (c) Long call+ long put Profit Price expectations Market price of asset Net (double premium Loss c) Long put + long call Profit Price expectations ㅡ ㅡ ㅡㅡ Market p of asset ! Net (double) premium Loss

Answer 1

Purchasing long calls means that the investor will have the option to purchase the underlying asset at the strike price after paying a premium, hence a long call will be in the money if the spot price increases above the strike price (the higher the price, the better). Purchasing long put means an option to sell the underlying asset at the strike price after paying a premium, hence a long put will be in the money if the spot price falls below the strike price (the lower the price, the better).

Under a 'long straddle', the investor has purchased both a long call and a long put on the same underlying asset, at the same strike price and for the same maturity. Hence, a long straddle will be profitable in two cases:

(i) When there is a large enough up movement in the price so that the profit gained on long call options can suppress the losses resulting from the long put.

(ii) When there is a large enough down movement in the price so that the profit gained on long put options surpasses the losses incurred on the long call.

Although, if the price remains unchanged, both the long call and long put will be out-of-money and will be discarded. But a premium had been paid in both long call and long put resulting in an aggregate loss of both the premiums.

Under a 'Long strangle', the long call has a slightly higher strike price than the long put. This is what results in a decrease in loss if the price remains unchanged or between the strike prices of the long call and long put. Here also the investor pays premiums on both long call and long put which is the aggregate loss for the investor. But, this aggregate loss is lower than that of a 'long straddle' because of the lower strike price of the long put. Since, the strike price on the long put option is lower, the premium paid on the same is also lower compared to a straddle which results in a lower amount of double premium.

So, when the price remains unchanged, both 'long strangle' and 'long straddle' would pay double premium as their loss but the double premium for a 'long strangle' is lower than the double premium of a 'long straddle' resulting in a reduced loss.