Prediction markets are fast becoming one of the most popular ways to trade both stocks and cryptocurrencies. Trading prediction markets can be very profitable when the right strategies are employed. Often, trading requires you to balance getting the right kind of information and choosing the precise strategies. It is never easy to predict how a market will move, sometimes leading to huge losses.
While trading the prediction market is often associated with fewer risks, some strategies can reduce the risk and provide the trader with higher returns. Over the years, traders have appreciated the need for good trading strategies, especially during volatile seasons. One such strategy while trading prediction markets is the strangle strategy.
What is the strangle strategy?
The strangle strategy is a unique strategy used by traders to trade in volatile markets. The strategy involves holding both a call and a put on the same underlying asset. During this period, the trader hopes to buy low and sell high or vice versa. The trader aims to purchase a call higher than the current price and a put lower than it.
A trader who employs a strangle as their strategy has the potential of profiting whether the market goes up or down. The trading strategy protects traders in the instances when the market does not go as expected.
There are two kinds of strangle strategies which include long strangle and short strangle. Long strangle can be defined as the process of buying an out-of-money call and out of the money put in the same asset. These buys have an exact expiry date. The trader will always get a net profit for a long strangle as long as the price moves sharply in either direction. This is because the contract that expires in the money will most likely compensate more than the loss caused by the contract that expires out of money. Usually, the long strategy is applied when a trader perceives a drastic change in the asset’s implied volatility.
The short strangle strategy can be defined as how a trader sells a call and put option. This is done respectively out of money. Thus, a short strangle is neutral with limited profit potential. A trader only profits when the price of the underlying asset trades in a narrow range, usually between the breakeven points. Many prediction markets platforms, however, do not support this method of trading.
How to trade a strangle?
In this strategy, the basic principles are to buy low and sell high. Thus, two trades are involved when implementing the strangle strategy in prediction markets. The first one is to sell an in-the-money (ITM) option, while the second is to buy an out-of-the-money (OTM) Option.
For instance, if an upcoming fundamental factor (like news) might cause the prices in the market to drop down so far, then that becomes a trader’s OTM while the selling price becomes their ATM. The market might bounce so many times that a retracement results in the trader profiting on both sides.
Sometimes a trader may choose to set a limit order on both sides of the trades, usually about 1.5 or 2 times. This helps the trader have a profit level allowing them to profit no matter the market’s direction. Normally, the limit orders are set at the outset of the trade.
Before starting any trade, traders need to check their charts and ensure they use the right bars, and it is preferred to have diagnostic bars. Traders should also check the expected ranges to see what are the set expiry times.
Benefits of using the strangle strategy
There are many perks of choosing a strangle strategy for prediction markets trading. Firstly, strangles are the ideal strategies to use when taking advantage of moving markets. Traders enjoy the direct neutral approach that allows them to profit regardless of the market direction.
Strangles also eliminate the need for stops as commonly required in other strategies. Usually, a trader is made aware of the maximum risks before starting the trade.
Lack of stops also means that one has the opportunity to see their trade through to expirations and avoid losses, which are a result of stopping out of a trade too early.
A trader can also resell their options when they become less certain the stock price will be moving in the desired direction.
Lastly, traders only lose the amount they put into the trade. Strangles offer traders a unique combination of unlimited profits but limited losses.
Disadvantages of using strangles as strategies
While the strangle strategy has several benefits, there are a few downsides to choosing it as a prediction markets trading strategy. There is always the matter of limited time. Traders will always have to bet that the asset price will move enough before the set expiration date.
Another downside is the risk of 100% loss. While the loss is limited to the price a trader paid for the options, a loss means losing 100% of the invested asset when it comes to percentage.
Another disadvantage is that the strategy relies heavily on drastic movement in the market. If the market moves moderately in any direction, the trader’s stance is to earn less if the asset does not cross over one option strike prices to surpass the total premium paid.
While choosing a strangle in prediction markets may be profitable, there is always room for losses. Trading Options, like any form of trade, require one to conduct their due diligence. Traders should not lightly choose strangles as a trading strategy before fully understanding the benefits and risks associated with the strategy. Traders should also ensure they have reliable sources for getting the correct upcoming news to avoid making losses. Lastly, you need to understand why this particular strategy is important and whether or not it is in line with your trading plan.