Let us discuss two popular options strategies that are designed to gain advantage out of the volatile markets commonly known as Strip and Strap. The basic concept behind the formulation of these strategies is somewhat similar to the straddle and strangle, however it is just the higher inclination on the direction of the movement is what makes these strategies different. Like Straddle and Strangle the risk involved or the cost remains limited while the reward remains potentially unlimited in both of these methods. We now take up each of these strategies in detail before drawing a comparison between them.
What is strip & strap option in online trading & how does it works
Executing a Strip includes simultaneously buying 1 lot ATM (at the money) call option and 2 lots ATM put options of the same expiry. Under this strategy one bets upon high volatility in the underlying instrument subsequent to a crucial event, the outlook however remains somewhat neutral to bearish. This is a net debit transaction where the breakeven on the upside is Strike price minus net debit, which is more than that of buying a straddle (as it involves buying two put options). On the other hand the break even on the lower side becomes closer to the strike price as compared to the straddle. Buying double put option make this strategy more expensive initially but in instances where the price breaks down sharply the profit also starts multiplying by a factor of two , leaving the opportunity to reap huge profits.
Executing a strap includes simultaneously buying 2 lots of ATM (at the money) call options and 1 lot of ATM put option of the same expiry, understandably to take advantage out of the high volatility preferably on the upside, which makes the outlook neutral to bullish. This is also a net debit transaction and the breakeven on the lower side is stretched far so as to compensate the cost of two call options while the same factor helps to bring the breakeven closer to the strike price on the way up.
Let’s understand both the strategies better with an illustration:-
ABC Ltd. Stock trading at Rs 1000 on 15 June, 2015
Also Read : Options Strategy: Straddle and Strangle
Low implied volatility- In Stock trading, before executing either of the strategy one must check that the implied volatility of the underlying is low and has fair chance of giving a breakout. A close look at the charts can help in this regard , one should look out for consolidation patterns like flag, pennants or triangle formation that warrant a sharp price movement after the breakouts. Factors to consider while executing Strip and Strap Strategy:-
- Time to expiry- Time decay is harmful for the strategies given the fact that the time value decreases exponentially as the time to expiry comes near, therefore one should enter when there is sufficient time to expiry.
- Immediate exit- Once the event is past one should be looking to exit the strategy immediately. In a profitable situation one can book profit in the profitable leg and wait for some retracement to exit the other leg, while in the situation when the strategy did not work out even in that scenario one should exit both the legs to save the premiums which will reduce further as the time passes.
We discussed how with the help of options we can take advantage of volatile situations arising in the stock markets. In our next articles we will take up with few other popular strategies that work out in other form of the markets.