Strap

Strap

Post By - Laxmi Mahera
Review By : Rohan Sharma
Updated on : October 26, 2021

Basics Concepts – Strap

Description - Strap

The Strap is a simple adjustment to the Straddle to make it more biased to the upside.
Only do a Strap on a stock that is close to making an announcement, such as the week before an earnings report.
The closer we get to expiration, the less time value there is in the option. Time decay accelerates exponentially during the last month before expiration
Try to find a stock that is forming a consolidation pattern, such as a flag or pennant
Buy one ATM strike put with the same expiration.
Buy two ATM strike calls
Keep the ratio as two Calls for one Put.

Introduction to Strap

Outlook

With straps, your outlook is neutral to bullish. You are looking for increasing volatility with the stock price moving explosively in either direction, preferably to the upside.

Rationale

To execute a neutral to bullish trade for a capital gain while expecting a surge in volatility to the upside.
Ideally you are looking for a scenario where Implied Volatility is currently very low, giving you low option prices, but the stock is about to make an explosive move—you don’t know which direction, but you have a bias toward the downside.

Net Position

This is a net debit transaction because you have bought calls and puts.
Your maximum risk on the trade itself is limited to the net debit of the bought calls and puts.
Your maximum reward is potentially unlimited.

Effect of Time Decay

Time decay is harmful to the Strap. Never keep a Strap into the last month to expiration because this is when time decay accelerates the fastest.

Time Period to Trade

We want to combine safety with prudence on cost. Therefore the optimum time period to trade straps

Breakeven Down = [Strike – net debit ]

Breakeven Up = [Strike + Half the net debit]

Steps to Trading a Strap

Steps In

Actively seek chart patterns that appear like pennant formations, signifying a consolidating price pattern.
Try to concentrate on stocks with news events and earning reports about to happen within a weeks.
Choose a stock price range you feel comfortable with.

Steps Out

Manage your position according to the rules defined in your Trading Plan.
Exit either a few days after the news event occurs where there is no movement, or after the news event where there has been profitable movement.
If the stock thrusts up, sell the calls (making a profit for the entire position) and wait for a retracement to profit from the put.
If the stock thrusts down, sell the put (making a profit for the entire position) and wait for a retracement to profit from the calls.
Try to avoid holding into the last month; otherwise, you’ll be exposed to serious time decay.

Exiting the trade - Strap

Exiting the Position

With this strategy, you can simply unravel the spread by selling your calls and puts.
You can also exit only your profitable leg of the trade and hope that the stock retraces to favor the unprofitable side later on.

Mitigating a Loss

Sell the position if you have only one month left to expiration. Do not hold on, hoping for the best, because you risk losing your entire stake.

Advantages and Disadvantages

Advantages

Profit from a volatile stock moving in either direction.
Capped risk
Uncapped profit potential if the stock moves.

Disadvantages

Expensive—you have to buy the ATM call and puts.
Significant movement of the stock and option prices is required to make a profit.
Bid/Ask Spread can adversely affect the quality of the trade.
Psychologically demanding strategy.

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