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Learn How To Read This Chart
Strap strangle - Introduction
The Strap strangle, also known simply as a Strap, is a
long strangle which buys more call options than put options and has a bullish inclination.
As a
Volatile Options Strategy, Strap strangles are useful
when the direction of a breakout is uncertain but is inclined to upside. Strap strangles make a higher profit than a regular strangle when the underlying stock breaks upwards but will make a lesser profit
than a regular strangle when the underlying stock breaks upwards.
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Main Differences Between Strap strangle and Regular Long strangle
The main difference between the Strap strangle and the regular long strangle is that Straps buys more
call options than
put options. A regular long strangle buys the same number of
out of the money put options and call options and has a symmetrical risk graph with equal profit to upside and downside. Strap strangles buy more out of the money call options than put options, resulting in a
risk graph with steeper gains to upside than downside. Strap strangles would also have a farther downside breakeven point than upside as the lesser put options need to overcome the premium cost of more call options.
Strap strangle Versus Regular strangle Example
Assuming QQQQ trading at $43.57.
Assuming Jan $44 Call costs $1.80 and Jan $43 Put costs $1.63
Regular Long strangle
Buy To Open 1 contract of Jan $43 Put at $1.63
Buy To Open 1 contract of Jan $44 Call at $1.80.
Net Debit = 1.63 + 1.80 = $3.43
Strap strangle
Buy To Open 1 contract of Jan $43 Put at $1.63
Buy To Open 2 contracts of Jan $44 Call at $1.80.
Net Debit = 1.63 + (1.80 x 2) = $5.23
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The regular strangle can also be given a bearish inclination through buying more put options than call options, creating a
Strip strangle. Strip and Strap are the two variants of the strangle that options traders can use to introduce a bearish or bullish inclination to their strangles.
Main Difference Between Strap Strangle and Strap Straddle
The
Strap Straddle is a cousin of the Strap strangle and it too buys more call options than put options. The main difference between a strap strangle and a strap straddle is that a strap strangle buys out of the money options instead of at the money options. This made the strip strangle cheaper in terms of net debit than the strip straddle but it also made the breakeven points further away. As such, strip strangles are a better choice only when the underlying stock is expected to make a breakout of significant magnitude. Indeed,
options trading is all about trade offs.
When To Use Strap strangle?
One should use a Strap strangle when one speculates that an uncertain stock might breakout to upside .
How To Use Strap strangle?
Buy to Open more Out of The Money (OTM) Call Options and Buy to Open Out of The Money (OTM) Put options.
Strap Strangles typically buy twice as much call options than put options.
Strap strangle Example
Assuming QQQQ trading at $43.57.
Buy To Open 1 contract of Jan $43 Put at $1.63
Buy To Open 2 contracts of Jan $44 Call at $1.80.
Net Debit = 1.63 + (1.80 x 2) = $5.23
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Trading Level Required For Strap Strangle
A Level 2 options trading account that allows the buying of call and put options is needed for the Strap Strangle. Read more about Options Account Trading Levels.
Profit Potential of Strap strangle :
Strap strangles have unlimited profit potential as long as the stock continues moving in one direction.
Profit Calculation of Strap strangle:
Profit = [(Stock price - strike price of Strap strangle) x number of call options (if stock is higher) or number of put options (if stock is lower)] - net debit
Maximum Loss = Net debit when stock closes at the options strike price.
From the above example :
Assuming QQQQ Rallies To $57
Profit = [(57 - 44) x 2] - 5.23 = 26 - 5.23 = $20.77 or 397%
Maximum Loss = $5.23
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Risk / Reward of Strap strangle:
Upside Maximum Profit: Unlimited
Maximum Loss: Limited
Breakeven Points of Strap strangle:
A Strap strangle makes a profit if it goes above its upper breakeven point or below its lower breakeven point.
Lower Breakeven Point = Put Strike price - net debit
Upper Breakeven Point = Call Strike price + (net debit/[number of call options/number of put options])
From the above example :
Lower Breakeven Point: 43 - 5.23 = $37.77
Upper Breakeven Point: 44 + (5.23/[2/1]) = 44 + 2.61 = $46.61
You would notice at this point that a Strap strangle has a nearer upper breakeven point than its lower breakeven point. This is the effect of buying more call options than put options.
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Advantages Of Strap strangle:
:: Higher profit than a regular strangle if stock breaks out to upside.
:: Closer upper breakeven point.
Disadvantages Of Strap strangle:
:: Higher minimal cash outlay needed.
:: Higher maximum loss than a regular strangle.
Alternate Actions for Strap strangles Before Expiration :
1. If the underlying asset has rallies and is expected to continue rising, you could sell to close the put Options and
hold the long call Options.
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