The strap is a modified, more bullish version of the common straddle. It involves buying a number of at-the-money puts and twice the number of calls of the same underlying stock, striking price and expiration date.
|Buy 2 ATM Calls|
Buy 1 ATM Put
Straps are unlimited profit, limited risk options trading strategies that are used when the options trader thinks that the underlying stock price will experience significant volatility in the near term and is more likely to rally upwards instead of plunging downwards.
Large profit is attainable with the strap strategy 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.
The formula for calculating profit is given below:
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 loses the entire initial debit taken to enter the trade.
The formula for calculating maximum loss is given below:
There are 2 break-even points for the strap position. The breakeven points can be calculated using the following formulae.
Suppose XYZ stock is trading at $40 in June. An options trader implements a strap by buying two JUL 40 calls for $400 and a JUL 40 put for $200. The net debit taken to enter the trade is $600, which is also his maximum possible loss.
If XYZ stock price plunges to $30 on expiration in July, the JUL 40 calls will expire worthless but the JUL 40 put will expire in-the-money and possess intrinsic value of $1000. Subtracting the initial debit of $600, the strap's profit comes to $400.
If XYZ stock is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the two JUL 40 calls expires in the money and has an intrinsic value of $1000 each. Subtracting the initial debit of $600, the strap's profit comes to $1400.
On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 calls expire worthless and the strap suffers its maximum loss which is equal to the initial debit of $600 taken to enter the trade.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).
The following strategies are similar to the strap in that they are also high volatility strategies that have unlimited profit potential and limited risk.
The strip is a modified straddle that has a bearish bias on the profit/risk potential.
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