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Strap Straddle is one of the market-neutral trading strategies with profit potential on both sides of the underlying price movement. The Strap Straddle is in fact a “bullish” market neutral strategy providing double the profits on upside price movement as compared to equivalent downside price movement. (a “Strip Straddle” in contrast, is a bearish market neutral strategy).
This strategy consists of buying a number of at-the-money puts and twice the number of at-the-money calls of the same underlying asset, expiration date and strike price.
Therefore, one can use it when he is expecting a big movement in the price of the underlying stock, although not completely sure in which direction, but predicts an upward movement is more likely than a downward one. It will profit from a big movement in either direction, but will make higher profits in an upside movement.
Strap Straddle Construction
Execution of the Strap Straddle strategy involves buying at the money calls and at the money puts. The only point is one needs to buy a higher number of calls than puts:
- Buy 1 ATM Put
- Buy 2 ATM Calls
The main choice one needs to make is what ratio of calls to puts to use. As a starting point, a 2 to 1 ratio is suggested but one can adjust this as he finds it suitable.
Large profit is achievable with this strategy when the underlying asset price makes a strong movement either downwards or upwards at expiration, with greater gains to be realized with an upward move.
The formula for calculating profit is:
- Profit Achieved when Price of Underlying < Strike Price of Puts/Calls – Net Premium Paid or when Price of Underlying > Strike Price of Calls/Puts + (Net Premium Paid/2)
- Profit = 2 x (Price of Underlying – Strike Price of Calls) – Net Premium Paid or Strike Price of Puts – Price of Underlying – Net Premium Paid
- Maximum Profit = Unlimited
The maximum loss for the strap straddle is limited and occurs when the underlying asset price on the expiration date is trading at the strike price of the Put and Call options bought. At this level, all the options expire worthless and the trader loses the entire premium paid to enter the trade.
The formula for calculating maximum loss is given below:
- Max Loss = Net Premium Paid + Commissions Paid
- Max Loss occurs when Strike Price of Puts/Calls = Price of Underlying at expiration
- Maximum Loss = Limited
There are 2 breakeven points for the Strap Straddle position:
- Lower Breakeven Point = Strike Price of Puts/Calls – Net Premium Paid
- Upper Breakeven Point = Strike Price of Calls/Puts + (Net Premium Paid/2)
Applying Strap Straddle Strategy Using MarketXLS Template With an Example:
MarketXLS software is a one-stop solution for the analysis of your entire investments. It provides a host of functions like EPS, various ratios, key fundamentals, historical data, options pricing and much more to assess the value of your investments. It provides a variety of templates for various options trading strategies and also to compare your portfolio stocks for doing a better analysis of your investments.
Step 1: Enter the stock ticker in cell D6 and press enter. The template will provide the upcoming expiry dates for the stock and the current market price. Select any one of the expiry dates.
Link to the template: https://marketxls.com/template/strap-straddle/
Step 2: Enter the ATM strike price for Put and Call options bought in cell D12.
Step 3: The template might ask you to refresh. Go to the MarketXLS tab in the ribbon > Refresh All. Click on Refresh All.
The template uses the bid price for sells and ask price for buys to calculate the amount of premium to be paid by you.
Step 4: The template also provides the Net Payoff Profile of the strategy. You need to enter the expected minimum and maximum expiry prices for the period. It will calculate the net profit or net loss for all the levels of expiry prices for all the options positions and present it graphically.
Apple Inc. (AAPL) as an example in the above template:
AAPL stock is trading at levels of $145 on 10th August, 2021. I have selected the upcoming expiry of 20th August, 2021 to enter the trade. I believe that the stock has more potential to go upside than downside in the near term. So I am executing a Strap Straddle position by buying 2 ATM Calls and 1 ATM Put @$145.
The template will calculate the premium amount for the options and thus calculate the net cash flow for entering the trade, which is $606 debit in this case.
[ 2*100*2.35 (Call strike @$145) + 1*100*1.36 (Put strike @$145) = -$606 ]
Suppose if the stock price plunges to $130 on the expiration date, the Call options will expire worthless but the Put option will expire in money with an intrinsic value of $1500. Considering the initial debit of $606, my net profit will come to $894.
Suppose if the stock price soars to $160 on the expiration date, the Put option will expire worthless but the Call options will expire in money with an intrinsic value of $3000. Taking into account the initial debit of $606, my net profit will be $2394.
Thus, it is clear that profit gets doubled when the stock price rises. However, there is no limit to the profit attainable if the price breaks out in any direction.
Suppose if the stock price keeps trading at $145 on the expiration date, both the Put and Call options will expire worthless and the strap suffers its maximum loss which is equal to the initial debit of $606 taken to enter the trade.
Here is a video explaining the Strap Straddle options strategy using MarketXLS:
The Strap Straddle strategy is simple enough to make it suitable for beginners who do not have a thorough knowledge of the stock markets. It is a great alternative to the Strip Straddle if you believe that the price of the underlying security is more likely to break out to the upside than the downside. This might be a good strategy to try just before earnings reports, if you’re expecting some huge revelation or bad news.
One would probably want to choose an expiry date in the very near future, otherwise he will have to pay a lot of time premium on the contracts with longer dates.
There are only two transactions involved, so the commissions aren’t particularly high, and there are no margin requirements.
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