Strangle Top Vertical Combination

Strangle Top Vertical Combination

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

Let us assume that the trader writes put options with strike price K1 and writes call options with higher strike price K2.  In this method, the trader will enjoy cash inflow from writing options, unlike the Strangle Bottom Vertical Combination . The presumption is all options should expire on the same time.

Strangle Top Vertical Combination

 Strangle Top Vertical Combination K55 K1 55 K2 60

(compute based on: options volatility 35%, 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 write price of put option with underlying strike price K1, P2 be write price of call option with higher underlying strike price K2. The assumed current price of underlying is in between K1and K2.

Strangle Top Vertical Combination

Profit Table

Initial Cash Outlay = P1 + P2

Underlying Price Range Payoff from Short Put Option at K1 strike Payoff from Short Call Option at K2 strike Total Payoffs
ST ≤ K1 -(K1 – ST) 0 P1 + P2 – (K1 – ST)
K1 < ST < k2 0 0 P1 + P2
ST ≥ K2 0 -(ST – K2) P1 + P2 -(ST – K2)

 

In the model of Strangle Top 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 Top Vertical Combination can be viewed as a profit capped trade as profit is limited to P1 + P2. Alternatively, the Strangle Top Vertical Combination is a very low reward high risk trade because loses are unlimited if prices of underlying asset goes up beyond K2or moves well below K1.

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

Strangle Top Vertical Combination K60 K1 55 K2 60

(compute based on: options volatility 35%, 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. 

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