Question

What trading position is created from a long strangle and a short straddle when both have the same time to maturity? Assume that the strike price in the straddle is halfway between the two strike prices of the strangle.

Answer 1

Long strangle is buying of an out of the money option which is call option and buying of another out of the moneyoption which is put option.

long strangle is prepared when the trader believes that there would be high swings in the prices of stocks and he wants to gain from those high wings by taking a risk neutral strategy.

short straddle is a strategy in which the trader will short one call and short one put of same stock of same expiry and he believes that the stock is not going to move much up or move much down so he expect the stop to remain in a range and he wants to eat the premium to gain the profit.

If we mix two strategies, we will arrive at a trader holding one out of the money call option and one out of the money put option and selling one in the money call option and selling another in the money put option so it would be a strategy which is completely neutral.