Why might a trader prefer a strangle to a straddle?
If a trader thinks implied vol will rise, wouldn’t he always prefer to own a straddle (with more vega) than a strangle?
Not necessarily. And this is usually because of vomma. Vomma is a higher order Greek which is zero for at-the-money options but positive for out-of-the-money options. So owning a strangle means owning vega and vomma. Whereas a straddle only brings vega. Which leads to the question; what are the benefits of owning vomma?
Vomma is a bit like ‘vol gamma’. If a position is long vomma, changes in implied vol always have a silver lining; so if a trader is long strangles then she is long vega and so falling vol is bad news but at least, due to vomma, the trader is becoming a little less long vega. Correspondingly, if vol increases, the vomma increases the vega position. So either way, vomma contributes in a beneficial way. Of course the vega risk tends to dominate day-to-day but vomma often matters a great deal in large vol moves. A trader might be long straddles and short strangles and therefore net long vega. It is not impossible in a large upswing in vol for his position to suddenly turn short vega as the strangles kick in via their short vomma. Looking at the portfolio vomma, this can be anticipated but it is surprising how many traders still shout at desk assistants for making a mistake in the position somewhere when they are not as long vega as they expected to be!
The strangle compared lot-for-lot with a straddle cannot have bigger vega, but if it is not compared lot-for-lot then it could. So a trader might have the choice between buying 150 strangles or 100 straddles which both come to the same amount of total vega. Some traders might argue in favour of the strangle because it brings some long vomma. It is just one factor that could influence the decision which will also include the price of option skew (and therefore whether any premium is being paid for the strangle over the straddle).
Have a question for the author? Happy to help! Email [email protected].
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