Strangle Bottom Vertical Combination

Strangle Bottom Vertical Combination

The Strangle Bottom Vertical Combination Strangle, is formed when trader buys put options and the same number of call options with the different strike prices on the underlying asset.

Let us assume that the trader buys put a option with strike price K1 and buys a call option with higher strike price K2. In this method, the trader will suffer cash outflow from buy-ins, unlike the Strangle Top Vertical Combination. The presumption is all options should expire on the same time.

 Strangle Bottom Vertical Combination

 

(compute based on: options volatility 10%, risk free rate on options 10%, K $55, K1 $55, K2 $60 period 6 months, present value of initial cashflow neglected, equity) 

Let us assume P1 be buy-in price of put option with underlying strike price K1, P2 be buy-in price of call option with higher underlying strike price K2. The assumed current price of underlying asset is K = K1.

Strangle Bottom Vertical Combination

Profit Table

Initial Cash Outlay = – P1 – P2

Underlying Price Range Payoff from Long Put Option at K1 strike Payoff from Long Call Option at K2 strike Total Payoffs
ST ≤ K1 K1 – ST 0 K1 – ST – P1 – P2
K1 < ST < k2 0 0 – P1 – P2
ST ≥ K2 0 ST – K2 ST – K2 – P1 – P2

 

In the model of Strangle Bottom Vertical Combination using cash inflow method, the trader is of the opinion that the underlying price will remain in between K1 and K2 that there will be a profit.

The Strangle Bottom Vertical Combination can be viewed as a profit capped trade as profit is limited to P1 + P2. Alternatively, the Bottom Vertical Combination Strangle is a very low reward high risk trade because loses are unlimited going up and up to a maximum of K1 if prices of underlying dropped.

The reward is very low because K1 and K2 are some distance price away from the current underlying asset price, hence these options should not cost too much to buy.

Strangle Bottom Vertical Combination K60 K1 55 K2 60

 

(compute based on: options volatility 10%, risk free rate on options 10%, K $60, K1 $55, K2 $60 period 6 months, present value of initial cashflow neglected, equity) 

This trade is a form of volatility trade quite similar to the Straddle. This trade is profitable when option seller priced a low expectation of market volatility but actual market price is higher.

Best Options Trading for Dummies profits on Strangle Bottom Vertical Combination, Bottom Straddle, Top Straddle  using Options Trading 101.