Strip Strategy

8/8/2019 Strip Strategy

http://slidepdf.com/reader/full/strip-strategy 1/4

Strip Strategy:

It is an extension of Straddle. If straddle we assume volatility, but uncertain outlook, i.e. we donot know which side market will go. Here the trader still assumes same things; however he has a

little downwards bias.

So instead of buying one call and one put, he buys one call and two puts.

Strap strategy :

Here also Straddle buyer assumes the same outlook, but has a little upward bias. So instead of

buying one call and one put, he buys two calls and one put.

Strap Strategy

Posted on 16 December 2008 by Hiral Thanawala

The µStrap¶ strategy is one that can be beneficial in a bullish market. This is the bullishadaptation of the straddle strategy. It involves buying a number of at-the-money puts and twice

that number of calls of the same underlying stock, at the same strike price and expiration date.

This strategy will play a vital role to earn good profits from equity/commodity markets when our

GDP numbers are getting stronger, micro and macro economic indicators are stabilizing andimproving, profits and sales are increasing, and FII/HNI participation to invest in these markets.

In the near term, it seems difficult to implement this strategy since market is in bear mode. Buteconomists expect a clearer picture of economic growth by end of Q2, 2009 for the BRIC

(Brazil, Russia, India, China) countries. So, keep the knowledge of this strategy in the mean timeand implement it at the right time to gain the advantage - when you are convinced that it is a bull

market rally and direction of the market in near term will remain upwards.

Profit Potentiality: This strategy has the potential to create large amounts of profit when theunderlying stock price makes a strong move either upwards or downwards at expiration, with

greater gains to be made with an upward move.

Risk: The risk is limited in this strategy. The maximum loss for the strap occurs when theunderlying stock price on expiration date is trading at the strike price of the call and put options

purchased. At this price, all the options expire worthless and the options trader losses the net premium and commissions paid to enter the trade.

Computation of break-even points:

There are 2 break-even points for the strap option strategy. The break-even points can becomputed as given below:

y U pper break-even point = Strike price of calls/puts + (Net premium paid/2)

y Lower break-even point = Strike price of calls/puts - Net premium paid



Example:

Consider, ABC stock is trading at Rs. 1000 in December. An options trader implements a strap by buying two January calls for Rs. 60 per share as premium for strike price of Rs. 1000 and a

January put for Rs. 50 per share as premium for strike price of Rs. 1000. The net debit taken to

enter the trade is Rs. 17000. Assume market lot size as 100 shares.

If ABC stock price reduces to Rs.500 on expiration in January, the January call will expire

worthless but the January put expires in-the-money and possesses intrinsic value of Rs. 50,000(Rs. 500 decline is stock price x 100 lot size). Reducing the initial debit of Rs.17000 the strap¶s

profit will be Rs.33000.

If ABC stock is trading at Rs.1500 on expiration in January, the January puts will expire

worthless but the January two call expires in the money and has an intrinsic value of 1 lakh (i.e.Rs. 50000 x 2 call options). Reducing the initial debit of Rs. 17000 the strap¶s profit will be Rs.

83000.

On expiration in January, if ABC stock is still trading at Rs. 1000, both the January puts and theJanuary call will expire worthless and strap will suffer the loss of the Rs.17000 that was paid as

premium to enter the trade.

The 2 break-even point in this case will be:

y U pper break-even point = Rs. 1000 (strike price) + Rs. 85 (Net premium paid /2) = Rs.

1085. y Lower break-even point = Rs. 1000 (strike price) - Rs. 170 (Rs. 60 x 2 call premium +

Rs. 50 put premium) = Rs. 830.

In this example the stock has to break the price band of Rs. 830 to Rs. 1085 to be profitable i.e.decline below Rs. 830 or appreciate beyond Rs. 1085. If the stock price fails to break the price

band upper and lower BEP investors will end up losing the entire premium paid for executingthis strategy.

The strap strategy can be the right option-trading approach for investors who are bullish on the

market and expect it to move upwards in the near future.

Welcome to another in a series of articles that examines the thought process behind a variety of

strategies using stock, index, and/or exchange-traded fund (ETF) options. This column willexamine the strap, the pros and cons of a strap, and the profit and loss potential of this position.So, let's jump into this interesting strategy.

First off, a strap is a modified, more bullish version of the common straddle. A long straddle is

the simultaneous purchase of an equivalent number of calls and puts on the same underlyingstock with the same strike and same expiration. The straddle buyer is looking for a large move by

the underlying shares before the options expire, but is unsure of the eventual direction of the



move. The straddle buyer will begin realizing a profit when the underlying stock's subsequentmove exceeds the amount of the combined premium paid for the two options.

A strap, meanwhile, involves buying a number of at-the-money puts and twice the number of

calls on the same underlying stock, all with the same strike price and expiration date. By design,

a strap has a bullish bias since there are twice as many calls as puts.

Stock and Option Selection

Since the success of the position is dependent on a strong move in the shares, a strap is typicallyinitiated ahead of a known event such as a mid-quarter update, an earnings report, a new product

release, or the release of a drug trial's results.

With the position dependent upon a stock's reaction to a specific event, a trader will typically purchase options as close to the event as possible. With less time value built into the equation,

the options could be relatively inexpensive. For example, if a company is set to report earnings in

mid-November, a trader would typically buy November-series options.

Let's Look at an Example

As we are deep into earnings season, the next month will be ripe with opportunities for potentialstrap positions. NetEase.com Inc. ( NTES: sentiment, chart, options), for example, is slated to

post earnings on Nov. 18. Analysts are currently anticipating a profit of 52 cents per share, whichis above the firm's profit of 36 cents per share for the same period a year ago. Historically, the

company has beaten the consensus estimate in three of the past four quarters.

Technically speaking, the shares of NTES have enjoyed a stellar rally, as the stock has soared

more than 84% since the beginning of the year. The equity's recent pullback was stopped bysupport at the 36 level, and the security has recently bounced back to reclaim support at itsascending 10-week moving average. This intermediate-term trendline had guided the shares

higher from late February through early October.



From a sentiment perspective, investors are extremely pessimistic when its comes to NTES. The

Schaeffer's put/call open interest ratio for the stock stands at 0.83, which is higher than 78% of

all those taken during the past 52 weeks. In other words, options players have been moreskeptical of the shares only 22% of the time during the past 12 months.

Furthermore, the International Securities Exchange (ISE) has seen an uptick in put buying.

During the past 10 trading sessions, 2.7 puts have been purchased to open for every one call purchased to open. This ratio is higher than 93% of all those taken during the past year, pointingto a growing pessimism.

Documents

Strip Strategy