Option Strangle (Long Strangle) Explained

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Long Strangle Option Strategy

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Expecting a big move from a stock but not sure of the direction? Then the long strangle option strategy is the trade for you.

This explosive options strategy can generate big profits in a short period of time, but, like any option strategy that involves owning long options, time is against you.

The big move needs to happen sooner rather than later, otherwise you will find your position slowly eroding each day from the dreaded time decay.

The long strangle also has a huge exposure to implied volatility. All else being equal, the trade will make money if implied volatility increases after opening the trade and lose money if implied volatility decreases.

Even if the stock doesn’t move, a spike in implied volatility due to an unforeseen event, might allow the trader to close out the position early for a profit.

Set Up

A long strangle is constructed by buying an out-of-the-money put and an out-of-the-money call with the same expiration date. Traders might prefer the long strangle over the long straddle due to the reduced cost. However, they will need a bigger move from the stock in order for the trade to be profitable at expiry. How far out-of-the-money to place the call and put would depend on the trader’s outlook for the stock and how much money they are willing to risk. Typically traders will place the calls and puts an equal distance away from the stock price. For example, it a stock was trading at $50, a trader might buy a $45 put and buy a $55 call.

PICKING A PRICE TARGET

If a trader was expecting a 10% move in the stock, they would want to place the strangle within that range. A strangle that has the two legs 10% away from the current price, will require a move of greater than 10% (at expiry) in order to profit due to the cost of the trade. However, this trade could still be profitable before expiry if there is a big move. This can be seen in the image below.

This trade was set up on June 15th, 2020 on RUT. The blue line represents the profit or loss at expiry and the purple line represents the profit or loss one week from trade initiation. You can see that a sizable profit is achievable one week after opening if the index moves about 5%. To make the same profit at expiry, the index needs to move over 7.5%.

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The strikes for this trade were just an arbitrary 50 points above and below the index price. Notice that because of the volatility skew , the 1210 put is significantly more expensive than the 1310 call.

USING DELTA

Another way to select the option strikes is to use delta as a guide. Delta can be used as a rough estimate of the probability of the stock reaching that strike at expiry. For example, a strangle trade that uses strikes with deltas around 0.30 and -0.30 has a roughly 30% chance of expiring in-the-money.

In the example above the deltas were 0.30 and -0.33. To make the trade completely delta neutral, you could swap the 1210 put for a -0.30 delta 1200 put. That way, the trade would start perfectly delta neutral , although it won’t stay that way for long. As the underlying index moves, the net delta on the trade will move to either positive or negative depending on which way the index moved.

Max Loss

The maximum loss on this trade is limited which is great, but a trader would not want to experience a 100% loss on this trade given the large amount of capital required.

Straddles and strangles are expensive and need to be managed carefully to avoid significant loss. Dan Nathan from Risk Reversal provides a good example of using a short straddle to offset the cost of a long strangle . This article is well worth a read if you are concerned about the cost of a long strangle trade.

The maximum loss will occur if the stock finishes between the put and call strikes at expiry. In this case both the put and call will expire worthless and the trader would experience a total loss.

Long Strangle Vs Long Straddle

With a long strangle, the options are placed out-of-the-money, whereas a long straddle uses at-the-money calls and puts. The straddle trade acquired its name due to the fact that the calls and puts “straddle” the one strike.

The strangle trade places the calls and puts on either side of the stock price and “strangles” the underlying stock or index. You can see the difference in the trade setup in the two images below.

You can see that the straddle is more expensive because you are trading the at-the-money options which have the highest time premium component. The long strangle is a cheaper trade to place, but requires a larger move before reaching the breakeven point. In this example, the straddle costs $800 and has breakeven points at $42 and $58 while the strangle costs $400 and has breakeven points at $41 and $59.

Entry Points

The long strangle is a trade which requires a large move in the underlying stock in order to be profitable. As such, one good entry criteria could be to wait until the stock has had a long period of sideways consolidation before entering the trade.

Generally, stocks tend to revert to their long term average movement, so after a quiet period, the stock could be ready to make a big move. Various chart patterns and techniques can be used to help guide you in when to enter these trades. Triangles, Channels, Wedges, Flags and Pennants are all relevant chart patterns that could be used for an entry criteria.

These patterns all exhibit similar characteristics in that the stock is either range bound or coiling in a tighter and tighter range, just before it breaks out. If you feel like a stock is ready to breakout, but are not sure of the direction, a long strangle is a great trade.

Here are some examples:

SYMMETRICAL TRIANGLE AND BREAKOUT

CHANNEL AND BREAKOUT

WEDGE PATTERN AND BREAKOUT

FLAGS, PENNANTS AND BREAKOUTS

More About Entries

Another important part of trade entry with a long strangle is to take a look at the current and expected level of implied volatility which we will discuss in more detail shortly. As straddles and strangles are long volatility trades you want to enter them when volatility is low and expected to rise.

One of my favorite entries for a long strangle trade is when you see a Bollinger Band squeeze. This works especially well when the Bollinger Band Width is near the lowest point seen in the last 6 months and when the stock price is near the middle of the very narrow Bollinger Bands. In the EWZ chart below, you can see two very favorable entries based on these criteria.

The first signal saw a move from $34.50 down to below $29 in 9 trading days. That’s a 16% move, and the fact that it occurred on the downside would have given a long strangle an even bigger boost due to the implied volatility expansion. Around that time, implied volatility moved from 31% to 38% which really helped the long strangle trade. Remember long strangles are positive vega and therefore benefit from a rise in implied volatility after the trade is placed.

The second signal occurred in mid-May and saw an 11% move from $36 to $32 in 10 trading days. Again, this occurred with an accompanying rise in implied volatility which gave the trade an extra boost. During this period, implied volatility rose from 26% to 32.5%.

These types of setups and moves only tend to occur a few times per year, but when you do catch them, the results can be outstanding.

I placed a long strangle trade on EWZ in my own account, although I was a few weeks early on the entry. You can see below that even though I entered the trade on February 4 th , I still made a handy profit. This profit would have been much larger if I had entered the trade towards the end of March.

Exits

It’s great when a trade goes to plan and you can take a profit. Generally, for a long strangle trade, I am happy with a 20-25% return on capital at risk and will tend to take profits at that stage or slowly scale out of the position.

On the downside, I tend to stick to a 20% stop loss.

Long strangles are a very theta intensive strategy and as time passes, the amount of time decay you suffer will increase exponentially. For this reason, it makes sense to close out long strangles once 1/3 of the time to expiry has passed. If neither my profit target nor stop loss have been hit, but this much time has passed, I typically close the trade to avoid the losses from time decay that are accumulating.

The Greeks

It goes without saying that the long strangle is a long volatility play. You’re looking for a big move in either direction, or a jump in implied volatility. The battle is between capturing that move, against the effects of time decay as each day passes.

The actual greeks will vary depending on how the trader sets up the trade, but typically most traders start off delta neutral or close to it. Vega will always be positive and theta will always be negative.

Let’s work through some scenarios together. The following three RUT long strangle trades were set up on June 15th, 2020.

The following three trades were placed when RUT was trading around 1260. The first trade was 3 months in duration and the strikes were placed 50 points out of the money. Here’s how the greeks look.

Trade 1 – Sept 1210 – 1310 Long Strangle

Here’s what the greeks look like if we use the same strikes but go out to January 2020.

Notice that delta is pretty similar and more or less neutral, no major change there. Theta has come down a bit. As we have gone further out in time, the impact of time decay on the trade is not as great. Vega has had a significant impact jumping from 451 to 729. So, by going out further in time, we have slightly reduced the time decay, but we have taken on a much greater exposure to changes in implied volatility.

What happens if implied volatility drops after we enter these trades instead of rising like we anticipated? The longer term trade (January expiry) would perform much worse as the impact of changes in implied volatility is greater.

Trade 2 – Jan 1210 – 1310 Long Strangle

This time, instead of going further out in time, we move the strikes out further while staying in September to make the trade a bit cheaper?

The first thing you should notice is that the implied volatility skew has become much more pronounced. The puts that are 100 points out of the money cost $17.15 as opposed to 100 point out-of-the-money calls at $5.05. As such the delta on the trade has become much more skewed to the downside. We now have -9 delta as opposed to -3 on Trade 1 and +1 on Trade 2.

Trade 3 – Sept 1160 – 1360 Long Strangle

Going further out from the index price has made the trade cheaper ($2,200 as opposed to $4,470), and our Vega exposure has dropped by about 30%, as has our theta. That’s all well and good, but with this trade, we would need the index to move further to be profitable at expiry.

In the short-term though (1-2 weeks), there isn’t a huge amount of difference. So, if you can really nail your timing, the further out-of-the-money strikes could potentially be more profitable on a percentage basis. But, you would have to be pretty spot on with your timing.

Here is the RUT and Russell Volatility Index as of June 15th, 2020 for reference.

10 Weeks Later

On August 24th, stocks experience a precipitous drop, with RUT falling to near 1100. This is a pretty big move from 1260 which is where RUT was trading when we initiated the trades. The majority of the decline occurred in mid-August, so you can see that things can develop quickly which is ideal for a long strangle.

Also notice that implied volatility skyrocketed, another massive bonus for a long strangle. Over the course of just a few days, RVX jumped from 17.50 to 47!! How do you think our long strangles performed in this scenario? Let’s take a look.

Trade 1 – Standard trade +$5,125 or 114%

Trade 2 – Further out in time +$2,525 or 26%

Trade 3 – Further out in price +$3,955 or 178%

You can see above that the two shorter-term trades (Sept) were the best performers in both dollar and percentage profit, both returning well over 100% on capital invested. This is interesting given that the January trade had the higher starting Vega.

Also note that after the decline, all three positions have a large negative delta. This is because the calls have very little value left and are very far out-of-the-money. Most of the value in the long strangle is in the puts. If the market bounced from here, the profits on the trades would quickly start to reverse. Definitely time to take profits!

The Impact of Implied Volatility

Implied volatility is a very important component of a long strangle. In the first example we looked at, vega was by far the dominant greek. If you refer back, you can see delta was -3, gamma was 1, theta was 41 and in comparison, vega was a whopp1ng 451! Therefore traders need to be aware, that changes in implied volatility will have a big impact on this trading strategy.

After entering the trade, if implied volatility rises, that will be very good for the trade, and the owner of the long strangle might be able to receive a higher premium when they sell to close the trade.

Volatility cuts both ways though, and if a fall in implied volatility occurs after the trade is opened, the value of the long strangle could fall significantly.

Implied Volatility and Earnings Announcements

An article on Schwab.com suggests opening a long strangle a few weeks prior to an earnings release. Many times you will see implied volatility at low levels a few weeks out from a stock’s earning’s report. Volatility then starts to rise as anticipation and uncertainty about the earnings report comes closer. You can see this very clearly in the chart of Google’s implied volatility below. There is a clear rise in implied volatility leading up to earnings releases in October, January and April. Following the earnings release, implied volatility drops dramatically, so the trader would want to close the long strangle before the announcement. Unless of course they are expecting a really big move in the stock.

The volatility drop following an earnings announcement is very common, you can see a good example with NFLX here .

Summary

The long strangle option strategy is a powerful strategy that can result in significant gains, but also has high risks. Some things to keep in mind include:

  • Long strangles have are a strategy that can produce large profits but also have the potential for big losses
  • You don’t need to predict which way the stock will move, only that it will make a big move shortly after you enter the trade
  • It is possible to make a profit from increases in implied volatility, even if the stock price does not change
  • The initial cost of the trade is high compared to other option strategies, but is still lower than the long straddle
  • The passage of time is not good for this trade. Traders need to stock to move (or implied volatility to rise) before too much time decay kicks in
  • Just as increases in implied volatility help the trade, decreases in implied volatility will hurt the trade

Let me know in the comments below if you have ever tried this strategy or if you plan to try it in the near future.

Long Strangle (Buy Strangle) Options Trading Strategy Explained

Published on Thursday, April 19, 2020 | Modified on Wednesday, June 5, 2020

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Long Strangle (Buy Strangle) Options Strategy

Strategy Level Beginners
Instruments Traded Call + Put
Number of Positions 2
Market View Neutral
Risk Profile Limited
Reward Profile Unlimited
Breakeven Point two break-even points

The Long Strangle (or Buy Strangle or Option Strangle) is a neutral strategy wherein Slightly OTM Put Options and Slightly OTM Call are bought simultaneously with same underlying asset and expiry date.

This strategy can be used when the trader expects that the underlying stock will experience significant volatility in the near term.

It is a limited risk and unlimited reward strategy. The maximum loss is the net premium paid while maximum profit is achieved when the underlying moves either significantly upwards or downwards at expiration.

The usual Long Strangle Strategy looks like as below for NIFTY current index value at 10400 (NIFTY Spot Price):

Options Strangle Orders

Orders NIFTY Strike Price
Buy 1 Slightly OTM Put NIFTY18APR10200PE
Buy 1 Slightly OTM Call NIFTY18APR10600CE

Suppose Nifty is currently at 10400 and due to some upcoming events you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty Put at 10200 and buying Nifty Call at 10600. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves.

When to use Long Strangle (Buy Strangle) strategy?

A Long Strangle is meant for special scenarios where you foresee a lot of volatility in the market due to election results, budget, policy change, annual result announcements etc.

Example

Example 1 – Stock Options:

Let’s take a simple example of a stock trading at в‚№40 (spot price) in June. The option contracts for this stock are available at the premium of:

  • July 35 Put – в‚№1
  • July 45 Call – в‚№1

Lot size: 100 shares in 1 lot

  1. Buy ‘July 35 Put’: 100*1 = 100
  2. Buy ‘July 45 Call’: 100*1 = 100

Net Debit: в‚№100 + в‚№100 = в‚№200

Now let’s discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at в‚№40

In this situation,

  • July 35 Put – Expires worthless
  • July 45 Call – Expires worthless
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Loss = в‚№200

The total loss of в‚№200 is also the maximum loss in this strategy.

Scenario 2: Stock price goes above в‚№50

In this situation,

  • July 35 Put – Expires worthless
  • July 45 Call Expires in-the-money with an intrinsic value of (50-45)*100 = в‚№500
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Profit = в‚№500 – в‚№200 = в‚№300

Scenario 3: Stock price goes down to в‚№30

In this situation,

  • July 35 Put Expires in-the-money with an intrinsic value of (35-30)*100 = в‚№500
  • July 45 Call – Expires worthless
  • Net Debit was в‚№200 initially paid to take the position.
  • Total Profit = в‚№500 – в‚№200 = в‚№300

Example 2 – Bank Nifty

Long Strangle Example Bank Nifty
Bank Nifty Spot Price 8900
Bank Nifty Lot Size 25
Long Strangle Options Strategy
Strike Price(в‚№) Premium(в‚№) Total Premium Paid(в‚№)
(Premium * lot size 25)
Buy 1 OTM Call 9000 200 5000
Buy 1 OTM Put 8800 100 2500
Net Premium (200+100) 300 7500
Upper Breakeven(в‚№) Strike price of Call + Net Premium
(9000 + 300)
9300
Lower Breakeven(в‚№) Strike price of put – Net Premium
(8800 – 300)
8500
Maximum Possible Loss (в‚№) Net Premium Paid 7500
Maximum Possible Profit (в‚№) Unlimited
On Expiry Bank NIFTY closes at Net Payoff from 1 OTM Call bought (в‚№) @9000 Net Payoff from 1 OTM Put Bought (в‚№) @8800 Net Payoff (в‚№)
8000 -5000 17500 12500
8300 -5000 10000 5000
8500 -5000 5000 0
9000 -5000 -2500 -7500
9300 2500 -2500 0
9500 7500 -2500 5000
9800 15000 -2500 12500

Market View – Neutral

When you are unsure of the direction of the underlying but expecting high volatility in it.

Actions

  • Buy OTM Call Option
  • Buy OTM Put Option

Suppose Nifty is currently at 10400 and you expect the price to move sharply but are unsure about the direction. In such a scenario, you can execute long strangle strategy by buying Nifty at 10600 and at 10800. The net premium paid will be your maximum loss while the profit will depend on how high or low the index moves.

Breakeven Point

two break-even points

A Options Strangle strategy has two break-even points.

Lower Breakeven Point = Strike Price of Put – Net Premium

Upper Breakeven Point = Strike Price of Call + Net Premium

Risk Profile of Long Strangle (Buy Strangle)

Limited

Max Loss = Net Premium Paid

The maximum loss is limited to the net premium paid in the long strangle strategy. It occurs when the price of the underlying is trading between the strike price of Options.

Reward Profile of Long Strangle (Buy Strangle)

Unlimited

Maximum profit is achieved when the underlying moves significantly up and down at expiration.

Profit = Price of Underlying – Strike Price of Long Call – Net Premium Paid

Profit = Strike Price of Long Put – Price of Underlying – Net Premium Paid

Long Strangle Option Strategy In Python

Introduction

Today, we are going to talk about the Long Strangle trading strategy.

What is ‘Long Strangle’ in Options trading?

Strategy highlights

Maximum Loss: Call Premium + Put Premium

Breakeven: Breakeven on the Upside = Strike Price + Call Premium + Put Premium

Breakeven on the Downside = Strike Price – Call Premium – Put Premium

How to implement this strategy?

Last 1-month stock price movement (source – Google Finance)

There has been a lot of movement in the stock price of Fortis, the highest being INR 157.30 and lowest being 114.20 in last 1 month. The current value being INR 138.90 as per Google Finance and an IV of 83.35%

For the purposes of this example; I will buy 1 out-of-the-money put and 1 out-of-the-money call Options.

Here is the option chain of Fortis for the expiry date of 22 nd February 2020.

I will pay INR 4 for the put with a strike price of INR 135 and INR 3.50 for the call with a strike price of INR 145. The options will expire on 22 nd February 2020 and in order for me to make a profit out of it, there should be a substantial movement in the Fortis stock before the expiry.

The net premium paid to initiate this trade will be INR 7.50 hence the stock needs to move down to INR 127.5 on the downside or INR 152.50 on the upside before this strategy will break even. Considering the massive amount of volatility in the market due to various factors and taking into account the market recovery process from the recent downfall we can assume that there can be an opportunity to book a profit here.

How to calculate the strategy payoff in Python?

Importing libraries

Defining parameters

Call payoff

Put payoff

Strangle payoff

As you can see in the above Payoff plot the maximum anyone can lose is the total premium paid for holding both call and put positions i.e. INR 7.50 in my case. This is when the strike price falls between the two options that we have purchased at the time of its expiry.

On the other hand, there is no limit for the profit that you can gain once the stock price moves significantly in any direction.

In my next post, I will be talking about the ‘Bull Call Spread Strategy’

Next Step

Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.

Long Strangle Screener

Stocks: 15 20 minute delay (Cboe BZX is real-time), ET. Volume reflects consolidated markets. Futures and Forex: 10 or 15 minute delay, CT.

© 2020 Barchart.com, Inc. All Rights Reserved.

About Long Strangle

A long strangle position consists of a long call and long put where both options have identical expirations and different strike prices. When purchasing a long strangle, risk is limited to the net debit paid (premium paid for both strikes). Profit potential is unlimited for this strategy. The strategy succeeds if the underlying price is trading below the lower price strike (minus net debit) or above the high price strike (plus net debit).

The screener results are initially sorted by descending “Break Even Probability.”

Options information is delayed a minimum of 15 minutes, and is updated at least once every 15-minutes through-out the day. The screener displays probability calculations based on the delayed stock price at the time the strategy is updated.

Main features of the Screener include:

  • Ability to add various filters, with hundreds of different combinations.
  • Save a Screener: When you’ve defined filters that you want to use again, save the screener.
  • Load a Saved Screener: Select a previously saved set of Screener filters to view today’s results.
  • View the Results using Flipcharts: Page through charts of the symbols on the results page.
  • Download the Results: Download up to 1000 results to a .csv file. The Download will also pull all of the data fields present on the View you use. Barchart Premier Members may download up to 100 .csv files per day.
  • Send an End-of-Day Email of a Screener’s Results: Barchart Premier Members can save a screener, and opt to receive 10, 25, or 50 results via email along with an optional .csv file of the top 1000 results. Emails are sent at 4:45pm CT Monday thru Friday.
Filters

Barchart Premier subscribers can add or modify different filters on the screener to find calls on the most favorable stock options.

Reordering Filters

Once filters are added, you may drag and drop them in the SET FILTERS tab to reorder the way they appear on the RESULTS tab (when using the Filters View). Each filter you add has the “Order” icon which is used to reposition it.

So you can focus on the best options, the screener starts by removing certain options:

  • Days to Expiration (both monthly and weekly expirations) is 60 days or less
  • Last Trade was made within the last 2 sessions
  • Security Type is only Stocks
  • The Break-Even Probability is greater than 25%
  • The Stock Price is greater than $1.00
  • The Options Volume for both legs must be greater than or equal to 100
  • Open Interest for both legs must be greater than or equal to 100
  • Ask Price for both Leg 1 and Leg 2 is greater than 0.05
  • Delta Leg 1 is between 10% to 20%
  • Delta Leg 2 is between -10% to -20%
  • Net Delta is between -5% and 5%

In addition, the option must not be an “adjusted” option (the option cannot be based on a split stock).

Note: “Restricted options” (options quotes marked with an asterisk * after the strike price, and found on an individual symbol’s options page) are automatically removed from the screener. A “restricted option” is typically created after spin-offs or mergers, and are not tradeable.

Probability Calculation

We take the underlying stock price, the break even point (target price), the days to expiration, and the 52-week historical volatility, and then use those figures in this formula. Depending on the strategy, we use the above or below probability (i.e., the probability the price crosses the break even point).

Pabove = N(d)
Pbelow = 1 – N(d)
where
N(d)= x if d > 0
= (1-x) if d and
d = 1n(b/l) / v√t,
y = 1/(1 + 0.2316419|d|),
z = 0.3989423e – (d*d)/2,
x = 1 – z(1.330274y⁵ – 1.821256y⁴ + 1.781478y³ – 0.356538y² + 0.3193815y)
and
b = break even point
l = last price
v = 52-week historical volatility
t = days to expiration
e = 2.71828

Views

The Results page contains three standard views. You may switch the view using the links at the top of the screener results table. The Main View shows the Volume and Open Interest for each option, while the Dividend & Earnings View can be used to highlight strategies with upcoming dividends and earnings. The Filter view shows you the data contained in the field(s) you’ve added to the screener.

Main View

  • Stock Symbol – the underlying equity. Clicking on the symbol will take you to the current quote page.
  • Last – the delayed stock price at the time the strategy is updated for the underlying equity.
  • Exp Date – the expiration date of the option
  • Leg 1 (Call): Strike, Delta
  • Leg 2 (Put): Strike, Delta
  • Net Debit – the cost to enter, or the break-even point for the call on expiration date. If the stock price is higher than the call’s Net Debit on expiration, the call will make a profit.
  • % of Stock – the percentage of the premium in relation to the underlying price of the stock
  • Avg IV – the average implied volatility of the calls and puts immediately above and below the underlying price.
  • -BE – the lower limit necessary for the strategy to break even (Leg2 Strike minus Net credit/debit)
  • +BE – the upper limit necessary for the strategy to break even (Leg1 Strike plus Net credit/debit)
  • Probability – the probability the last price will be at or beyond the break even point at expiration.

Dividend & Earnings View

  • Dividend – the dividend the equity pays on the Ex-Dividend Date. On the morning of the Dividend Ex-Date, the stock’s price is lowered by the amount of the dividend that was just paid.
  • Dividend Ex-Date – the first day on which the stock trades without the dividend. If you wish to receive the dividend, you must own the stock by the close of market on the day before the Dividend Ex-Date. Many times, a covered call is exercised early so the buyer can own the stock and collect the dividend. This typically happens to ITM options the day before the Dividend Ex-Date.
  • Earnings Date – The date on which a company is expected to release their next earnings report. The prices are more volatile, which tends to inflate the prices of the near-the-money strikes. During a contract period when there is an earnings report due, the earnings announcement can dramatically shift the range in which the stock has been trading.
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