Long-strangle premium hurdle and event volatility

Two wings, one premium budget

A long-strangle is the simultaneous purchase of an out-of-the-money call-option and an out-of-the-money put-option. The result is a directionally neutral stance that still requires a large move one way or the other.

The combined option-premium paid for both wings is the buyer's maximum risk and the hurdle that must be recovered before the position can show a profit.

Strike-proximity changes that budget. Strikes placed closer to the current futures price make the strangle more expensive because those rights are more valuable.

A gain on the favorable wing does not automatically produce a net profit, because the loss on the opposite wing must be overcome first.

A third outcome and a pre-event cost

In a consolidating market both the call-option and the put-option can lose value. Price-consolidation is a third path besides a rise or a fall, and it can defeat the long-strangle structure.

In a late-October 2013 e-mini S&P 500 illustration, a 1770 call-option and a 1720 put-option with 22 days to expiration each cost about $9.00 ($450), for a combined $18.00 ($900) of option-premium and maximum risk.

If that illustrated strangle were held to expiration, the futures would have needed to finish above 1788 or below 1702 to recoup both premiums.

Option prices often expand before a scheduled, widely anticipated release as the market prices in higher expected volatility. That event-implied-volatility raises the cost of buying a strangle in the days leading into the event.

Editorial reading of the archive workflow

Editorial interpretation: the historical steps are to add the two premiums, locate the expiration break-evens, and then check whether event-implied-volatility has already stretched that distance before a known release. This reading is a TradersWeek framing and is not a claim made by the archive.