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Description and use

Strap option is also version of the Long Straddle strategy. The difference here is an extra Long Call option. All components are ATM. Thus, trading Strip is more expensive and riskier than trading Long Straddle. The lower breakeven point is the strike price minus net debit. The net debit is higher than for the Long Straddle, because there are more Long Calls. The direction of the market is neutral/decreasing. The investor speculates on increasing volatility. The strategy is a net debit investment. The maximum loss is the amount of net debit, and the maximum profit is unlimited. The optimal maturity is three months. If the share prices aren’t moving, the position should be sold one month before expiration.

  • Type: Neutral, Bullish
  • Transaction type: Debit
  • Maximum profit: Unlimited
  • Maximum loss: Limited
  • Strategy: Volatility strategy

Opening the position

Strap Option Positions

Strap Option Positions

  • Buy one (ATM) Put option.
  • Buy 2 (ATM) Call options (same expiration and strike price as the Put option’s).

Steps

Entry:

  • Look for shares showing pennant or similar shapes on charts.

Exit:

  • When share prices are increasing, sell the Call option.
  • When share prices are decreasing, sell the Put option.

Basic characteristics

Maximum loss: Net debit.

Maximum profit: Unlimited.

Time decay: Time decay has a negative effect on the value.

Lower breakeven point: Strike price - Net debit.

Upper breakeven point: Strike price + (Net debit / 2).

Advantages and disadvantages

Advantages:

  • Profit is generated when the share price changes in any direction.
  • Limited loss.
  • The profit is potentially unlimited when share prices are moving.

Disadvantages:

  • Expensive.
  • The share price must change significantly to generate profit.
  • High Bid/Offer spread can have a negative influence on the position.

Closing the position

Closing the position:

  • Sell the Call and Put options.

Mitigation of losses:

  • Sell the position when there is one month left until expiry.

Example

Strap strategy example

Strap strategy example

ABCD is traded for $25.37 on 17. 05. 2017. The investor buys a Long Put option which has a strike price of $25.00, expires in August 2017. and costs $1.70 (premium). Then, buys 2 Long Call options which have a strike price of $25.00, expire in August 2017. and cost $2.40 (premium).

Price of the underlying (share price): S= $25.37
Premium (Long Put): P= $1.70
Premium (Long Call): C= $2.40
Strike price (Long Put): KP= $25.00
Strike price (Long Call): KC= $25.00
Net debit: ND
Maximum loss: R
Maximum profit: Pr
Lower breakeven point: LBEP
Upper breakeven point: UBEP

Net debit: ND = P + (2*C)
Maximum loss (risk): R = ND
Maximum profit: Unlimited
Lower breakeven point: LBEP = K - ND, where K = KP = KC
Upper breakeven point: UBEP = K + (ND/2)

ND = $6.50
R = $6.50
Pr = unlimited
LBEP = $18.50
UBEP = $28.25