Options 101: Strip & Strap – When the Market is Fluctuating!

In our last sessions, we covered a few popular strategies – protective puts, covered calls, straddles, strangles, iron condors, and calendar spreads. Today, we will continue to talk about two advanced strategies – the strip and the strap.

The Strip & Strap Overview

Both the strip and strap are built from three at-the-money (ATM) options with the same strike price and expiration date (that’s why they are referred to as “triple option” strategies). Think of them as the “expanded” versions of the long straddle — ideal when you expect high volatility but have a directional bias.

• The strap: buying 2 calls and 1 put – expect great fluctuation, but more likely up (bullish) 
• The strip: buying 1 call and 2 puts – expect great fluctuation, but more likely down (bearish)

Like straddles, the maximum loss from a strip/strap strategy is the premiums we paid to enter the position, which is limited. Whereas, the upside potential is unlimited; the further the price moves away from the current price, the higher the payoff. The price cannot drop below 0, so the payoff is limited on one side but unlimited on the other side – where there is no ceiling for price rallies. Let’s look at more details in the sections below.

The Strap – Bullish Bias

We long two at-the-money (ATM) calls and one ATM put, all of which expire at the same time. This is a bullish market-neutral strategy, which generates profit when the price moves in either direction, but more with an uptrend movement.

Let’s consider a typical example:

📌 Context:

• The underlying asset is ETH with a current price of $3600. The contract unit is 1 ETH.

📌 Action:

• Buy two call options with the strike price of $3600 at $500, expiring in 3 months
• Buy one put option with the strike price of $3600 at $400, expiring in 3 months
• The total premium paid: $500*2 + $400 = $1400

📌 Break-even points:

1. Breakeven at a lower price
   If the price of ETH drops below the strike price at expiration, the call options are out-of-the-money (OTM) and the put option is in-the-money (ITM). Then, we buy ETH in the spot market and exercise the put option to lock in the profit. In order to recover the loss from paying the premium, the price has to be $1400 less than the strike price ($3600)
   📝 The lower break-even price: $3600 – $1400 = $2200
   
2. Break-even at a higher price
   Similarly, in case of price increasing, we will profit from the 2 call options and choose to forfeit the put option. Simply exercise the call options – buying in ETH, then immediately sell them on the spot market. To break even, the intrinsic value of each call option contract should be $700 ($1400/2).
   📝 Thus, the upper break-even price is $3600 + $700 = $4300

The Strip – Bearish Bias

A strip consists of two ATM puts and one ATM call with the same expiration date. Traders use this strategy with the expectation that the market will show significant volatility with a bearish bias.

Let’s consider a typical example:

📌 Context:

• The underlying asset is ETH with a current price of $3600. 1 contract represents 1 ETH.

📌 Action:

• Buy one call option with the strike price of $3600 at $500, expiring in 3 months
• Buy two put options with the strike price of $3600 at $400, expiring in 3 months
• The total premium paid: $500 + $400*2 = $1300

📌 Break-even points:

1. Breakeven at a lower price
   When ETH falls below the strike price of $3600, we benefit from exercising the put options by buying at the spot price and selling them on the option contracts. To cover the amount of premium paid, each contract has to be worth $650 in intrinsic value.
   📝Therefore, the lower break-even point is $3600 – $650 = $2950
   
2. Break-even at a higher price
   Likewise, if the price is rising, we will exercise the call option, obtain ETH, and immediately sell at the spot price, pocketing the difference between the market price and $3600. To break even, the call option contract should give a payoff of $1300.
   📝 The upper break-even point: $3600 + $1300 = $4900

Further Discussion:

We discussed time decay in option trading in the latest Options 101 episode, stating that an option contract’s value declines over time because there’s less chance for a sudden price change. This theory stands corrected in this scenario, where options lose their extrinsic value as time goes by. Therefore, we are incentivized to exit the strategy early in order to lock in the profit or cut losses by preventing the options from becoming worthless.

Some scenarios when traders can consider exiting the strategies before expiration:

📌 Price hits an extreme

We continue to consider the ETH example with a strike price of $3600, expiring in 3 months. For example, the price rises to $5500 after 1 month.

In that case, the intrinsic value of the call option will increase sharply ($5500-$3600 = $1900) while the put option is deeply OTM (no intrinsic value). Both will have extrinsic value (time value) as it is 2 months left until expiration. If traders reckon this is the highest ETH can reach during its 3-month term, they can sell the call option now to immediately capture the profit and stop the extrinsic value from dropping further. Regarding the put option, if the move seems to be sustained and there’s less chance for a reversal in the next 2 months, the wise choice is to close the put option right away to save the premium erosion.

🔸The call option is worth $2000 ($100 time value & $1900 intrinsic value)

🔸The put option is worth $10 (time value only)

In this case, we can have these subsequent actions:

🔶For a strap, either:

• Sell 1 call (gain $2000), hold 1 call and 1 put. It becomes a straddle strategy, and we bet on the price to keep fluctuating but are neutral about the direction.
• Sell 2 calls (gain $4000), hold 1 put. We do this hoping for a bounce-back in price, and the put option will be ITM before or at the expiry date.
• Sell 1 put (gain $10), hold 1 or both calls. We reckon the price to maintain the uptrend, which makes the call eventually become valuable.
• Sell all 3 options (gain $4010). We believe that the price will not move much until the expiration.

🔶For a strip, we can:

• Sell 1 call and gain $2000, hold 1 or both puts (fully bearish exposure). We do this if we expect the price to make a reversal and the put options will become ITM.
• Sell all 3 options (gain $2020). We believe that the price will stop fluctuating so much for a while; thus, there is no need to exhaust the time value.

📌 Volatility spikes without a price move

When the volatility is up but the price has barely changed, the extrinsic values of options increase while the intrinsic value is nearly 0. The time value of options surges due to the increasing possibility of a big price movement. While not being able to capture the profit from the price change like we initially intended to, we still benefit from the inflated options premium. Traders can decide to exit the strategy early before the market volatility erodes, especially when it is caused by market announcements or short-term events.

📌 Price stalls

When we bet on market price movement in either direction but the price stays flat, it is wise to  cut losses early instead of waiting for the time value to erode. Some signals we can look out for:

• The market does not respond actively to news and events as we expected
• The volatility of the market tends to drop, or stays low for quite a long time, indicating that there is no upcoming price wave.

Conclusion

The strip or strap strategy is perfect for traders who want to bet on large market movements, yet are uncertain about the direction of the movements and still want to profit from both scenarios. A strap trader is biased towards an upward price move, while a strip trader expects a higher probability on a downtrend market.

Generally speaking, the price of the underlying asset can drop or rise way before the expiration date, or in the other spectrum, stays flat and unresponsive to catalysts. In that case, we can choose to exit the strategy early to lock in the profit or prevent the erosion effect of time decay.