Reasonably Thinking

Neutral strategies enable the investor to profit by neither taking a bullish nor bearish perspective.  Instead, the investor bets that a stock stays between two prices or moves outside two prices.  The tactics to execute this are called straddles and strangles.  Straddles and strangles require buying/selling a call and put on the same stock for the same duration.  “Straddle” is the term used for buying/selling a call and put at the same strike price; “strangle” is the term used for buying/selling a call and put at out of the money strike prices.  For simplicity, consider these terms interchangeable.

A short strangle is used when an investor believes that a stock will stay between two strike prices (in flat trading range).  Here the investor accepts a premium and waits for the option to expire.  If the stock price exceeds either the strike price on the upside or the downside, the investor could have significant losses.

(image from OptionsXpress)

A long strangle is used when an investor believes that a stock will venture outside of two strike prices (and is indifferent if the stock moves up or down, just as long as the stock moves significantly).  This tactic can be used if a major announcement (like earnings or sales data) is known to occur, but the content of the announcement is uncertain.  Here the investor pays a premium and wants the option to surpass the strike price on the upside or the downside.

(image from OptionsXpress)