This lesson on futures options spreads will be about the ‘Strangle’ spread.
This was the first futures options spread I utilized and it has served me well over the last several years.
The Strangle spread is best implemented when a market is in a sideways trend. As the name suggests, we will be wrapping around or ‘strangling’ the current market price action by selling both an ‘out of the money’ Call and an ‘out of the money’ Put in the same contract month. In doing so, we are choosing strike prices that we anticipate the underlying futures price will not reach in either direction prior to the options expiration date.
As you can see in the Japanese Yen chart below, the market was moving in a sideways trend for the several months. In reviewing the futures options strike prices, I would feel comfortable selling the 9000 Calls for 30 points ($375.00) and selling the 7700 Puts for 35 points ($437.50). Each point in the Japanese Yen futures and options contracts equals $12.50.
We’ve now collected a total of 65 points in total option premium ($812.50), which is the maximum gross profit in this spread (less commissions and trade fees). As long as the Japanese Yen futures prices do not reach either our 9000 Calls strike price or our 7700 Puts strike price prior to the options expiration date, our profit will be $812.50 at expiration. Of course, you can liquidate either or both of the options at any time prior to expiration for whatever the current market value is.
One of the benefits I like with the Strangle option spread is that if the market were to have a sudden large drop or big rally, I will have less of a loss than if I were not in an option spread.
For example, if Japanese Yen prices started to rally upwards, I would probably be losing money on the 9000 Call, but because this is a spread trade, we would be making money on the 7700 Put. If this situation were to occur, I would re-evaluate the trade to decide if I want to liquidate the entire spread, or, if I felt an upward trend was starting, I could just liquidate the Call and hold on to the Put to try to gain more profit and/or make up for any losses on the Call option.
Remember, even though this is a spread, there is no fixed amount of risk on a Strangle spread. Proper trade and money management must be used to determine how much money you are willing to risk prior to entering the trade. Also, always remember to account for commissions and trade fees when determining your profits and losses.
I hope you’ve found this futures option information valuable. If you have any questions on using this strategy, please feel free to contact me.
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