Strap
The Strap strategy is the bullish equivalent of the Strip strategy in options trading. It is applied when an investor believes that the underlying asset's price will experience considerable volatility but in a more strongly bullish direction. The strategy entails buying more call options than put options on the same underlying asset with the same expiration date and strike price. Usually, it is two calls for every one put. The Strap is essentially a leveraged bet on volatility with an expectation of a more pronounced upward move.
The Strap Setup
Imagine an investor who believes that there will be high volatility and an upward surge in a stock that is currently trading at $50. To use a Strap, the investor might:
- Buy two call options with a strike price of $50, paying a premium of $3 each.
- Buy one put option with the same strike price of $50, paying a premium of $2.
This gives a total cost of $8 ($6 for the calls + $2 for the put), which is the maximum potential loss.
Who Should Consider It
The Strap strategy works best for a trader who assumes that there are going to be huge market moves and he perceives more of a possibility that the price might rise more rapidly than that of falling in a stock. Especially when one predicts positive catalysts or expects more bullishness of the market side.
Strategy Explanation
In a Strap, the double calls are very likely to bring significant gains if the stock price surges substantially, and the single put provides a hedge and will gain if the stock price crashes severely. As this strategy has asymmetry and favors an upward move, it aligns with a bullish market view.
Breakeven Process
There are two breakeven points for the Strap:
- Upper Breakeven is the sum of total premium paid plus the strike price of calls.
- Lower Breakeven: Calculated by subtracting the total premium from the strike price of the put.
For our example, the upper breakeven would be $58 ($50 strike + $8 total premium), and the lower breakeven would be $42 ($50 strike - $8 total premium).
Sweet Spot
The sweet spot for this strategy is when the stock price is substantially above the upper breakeven point. The more the stock price rises above this point, the higher the potential profit, especially since the strategy includes more calls than puts.
Max Profit Potential
The maximum profit on the upside is theoretically unlimited because the stock price can keep going up forever. The potential profit on the downside, though large, is smaller compared to the upside since there are fewer puts.
Loss
The loss is capped at the total amount of premium paid if the stock price is at the strike price at expiration time since all the options would have expired worthless then.
Risk
The main risk here is that at the time of expiration, the stock price happens to be close to the strike price, and thus a total loss of the premium occurs.
Time Decay
Time decay (theta) negatively affects this strategy. The closer the expiration date gets without a significant move in the stock price, the more the value of both the puts and the calls will decay. This decay tends to accelerate as the expiration date approaches, eroding the value of the position unless a significant price move occurs early on.
Implied Volatility
An increase in implied volatility tends to favor the Strap as the value of options increases. It benefits from high moves, and higher volatility will increase the likelihood of such movements. Conversely, a decrease in implied volatility will be detrimental if it happens without the expected price movements.
Conclusion
The Strap strategy is a great way for traders who are bullish but also want to take advantage of potential volatility. It allows for a good way to leverage expectations of price movement upwards with some coverage for unexpected downturns, making it very attractive in bullish market conditions or in anticipation of positive news.