Strip Strategy:

It is an extension of Straddle. If straddle we assume volatility, but uncertain outlook, i.e. we do

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 ‘Strap’ strategy is one that can be beneficial in a bullish market. This is the bullish
adaptation 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 and
improving, 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. But
economists 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 time
and 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 the
underlying 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 the
underlying 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 be
computed as given below:
  Upper break-even point = Strike price of calls/puts + (Net premium paid/2)
 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 the
January 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:

 Upper break-even point = Rs. 1000 (strike price) + Rs. 85 (Net premium paid /2) = Rs.
1085.
 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 executing
this 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 will
examine 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 underlying
stock 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 subsequent
move 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 typically
initiated 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 potential
strap 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, which
is 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 by
support at the 36 level, and the security has recently bounced back to reclaim support at its
ascending 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 more
skeptical 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, pointing
to a growing pessimism.