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Believe it or not, one of the strangle strategies to enhance your investment return is by using options. When you buy and sell strangles, you would be taking advantage of both the call option and put option. Call options give you the right to buy the underlying asset, while put options allow you to sell off your stock at a predetermined price anytime during your contract period. The beauty lies in this long-term contract because each has its pros and cons and should be applied for better results. Check out Saxo forex broker for more in-depth information.
There are two instances where one can apply this particular strategy when market sentiment is high or low.
When sentiment is high
For instance, let’s look at the SIA counter-example during 2014-2015. Despite the many accidents that had happened to them, look at how strong market sentiment is towards this counter. Even after so many unfortunate events, the stock price has been largely unaffected and continued to rally up from S$1.86 in Jan 2014 to its 52-week high of S$10.57, which was achieved by 26 March 2015 before it recently retook a downtrend.
A strangle strategy should be applied when you believe that bullish or dovish sentiments will remain intact for a particular counter because you have increased chances of earning money from this investment opportunity.
When sentiment is low
After a dramatic fall due to an unfortunate event such as MH370 and MH17, look at how the stock price of Malaysia Airlines (MAS) kept rallying up to its 52-week high of RM4.54 but recently started a downtrend.
A strangle strategy should be applied when you believe that bearish or neutral sentiments will remain intact for a particular counter because you have increased chances of earning money from this investment opportunity.
The reasons for applying this strategy is evident enough where both call option and put option can make you earn returns during either time of the sentiment spectrum. In comparison, only an extremely bullish investor would buy call options, while a highly dovish investor would buy put options instead.
Four steps to follow:
Step 1
First, determine the approximate asset price that you believe will be within your contract period. We call it the ‘strike price’. Once you have chosen your strike price, you can now determine how much money is needed for investing.
Step 2
After that, look at the ‘term’ of your contract, which is how long you are willing to keep the investment for after which you will have decided whether or not to exercise your options. You have two choices here- American style and European style, where the latter restricts you from selling off your shares before expiration while the former allows you to do so without restrictions.
Step 3
You will be entering into the initial contract through buying call options or putting options to sell off immediately. It’s where your investment starts, but you should never forget to include the brokerage fees paid in step 2 once you have calculated your returns. The amount of money you will receive for this period will always depend on the market’s volatility as it is used as a measure for ‘gearing up’ or multiplying your earnings during this selling period.
Step 4
Since we are talking about investing in shares, you will be able to sell off your investments once the term of your contract is over. Once the market price has risen above your strike price, it would be more beneficial for you to exercise and sell off your call option at a higher price than what you have invested from step one, which will result in gains being made from selling the contracts.
In conclusion
Whenever you decide to cash out, remember to consider your brokerage fees, which were paid in step 2 and not what’s left after settling the bill for your initial investment. It would be unwise to assume that you will receive 100% of the total amount invested. At the same time, it is improbable to happen and considered as a lossless transaction, so always ensure that you have calculated your returns accurately.