Strap

The Strap strategy is a more bullish counterpart to the Strip strategy in options trading. It's used when an investor anticipates significant volatility in the underlying asset's price with a stronger bullish bias. This strategy involves purchasing more call options than put options on the same underlying asset with the same expiration date and strike price. Typically, the ratio is two calls for every one put. The Strap is effectively a leveraged bet on volatility with an expectation of a more pronounced upward move.

The Setup

Consider an investor who predicts high volatility with a potential upward surge in a stock currently priced at $50. To employ 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 results in a total cost of $8 ($6 for the calls + $2 for the put), representing the maximum potential loss.

Who Should Consider It

The Strap strategy is suited for traders who expect significant market movement and believe there is a higher probability of a sharp increase rather than a decrease in the stock price. It’s particularly useful during times of expected positive catalysts or bullish market sentiment.

Strategy Explained

In a Strap, the double calls offer the potential for substantial profits if the stock price rises significantly, while the single put provides a hedge and can profit if the stock price falls dramatically. The strategy's asymmetry, favoring upward moves, aligns with a bullish market outlook.

Breakeven Process

There are two breakeven points for the Strap:

Upper Breakeven: Calculated by adding the total premium spent to the strike price of the 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 occurs when the stock price significantly exceeds 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 as the stock price could rise indefinitely. The profit potential on the downside, while substantial, is limited compared to the upside due to having fewer puts.

Max Loss

The maximum loss is limited to the total premium paid if the stock price is exactly at the strike price at expiration, as all options would then expire worthless.

Risk

The primary risk is that the stock price ends up close to the strike price at expiration, leading to a total loss of the premium paid.

Time Decay

Time decay (theta) impacts this strategy negatively. As the expiration approaches without significant movement in the stock price, the value of both the puts and the calls will decrease. This decay tends to accelerate as the expiration date nears, eroding the value of the position unless a significant price move occurs early on.

Implied Volatility

An increase in implied volatility typically benefits the Strap since it increases the value of the options. The strategy profits from significant moves, and higher volatility increases the likelihood of such moves. Conversely, a decrease in implied volatility would be detrimental, particularly if it occurs without the expected price movements.

Conclusion

The Strap strategy is a powerful approach for traders who are bullish but also wish to capitalize on potential volatility. It provides a robust way to leverage expectations of upward price movements while maintaining some coverage for unexpected downturns, making it attractive during bullish market conditions or in anticipation of positive news.