Strip

Strip

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

Basics Concepts – Strip

Description - Strip

The Strip is a simple adjustment to the Straddle to make it more biased toward the downside.
Only do a Strip on a stock that is close to making an announcement that may cause a surprise jump in the stock price either way, such as the week before an earnings report.
Try to find a stock that is forming a consolidation pattern, such as a flag or pennant, or in other words, where the stock price action has become tighter and where volatility has shrunk in advance of a big move in either direction.
Never hold into the last of month before expiration. During the last of the month, your options will suffer increasing time decay, which we don’t want to be exposed to.
Buy two ATM strike puts, preferably months to expiration.
Buy one ATM strike call with the same expiration.
Keep the ratio as two puts for one call.

Introduction to Strip

Outlook

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

Rationale

To execute a neutral to bearish trade for a capital gain while expecting a surge in volatility to the downside. 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 Strip. Never keep a Strip 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 Strips

Breakeven Down = [Strike – Half of the net debit ]

Breakeven Up = [Strike + net debit]

Steps to Trading a Strip

Steps In

Actively seek chart patterns that appear like pennan formations, signifying a consolidating price pattern.
Try to concentrate on stocks with news events and earning reports about to happen within a weeks.

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 call (making a profit for the entire position) and wait for a retracement to profit from the puts.
If the stock thrusts down, sell the puts (making a profit for the entire position) and wait for a retracement to profit from the call.
Try to avoid holding into the last time of month; otherwise, you’ll be exposed to serious time decay.

Exiting the trade - Strip

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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