Due to the weighted nature of the strategy, the investor will need to purchase calls and puts in a specific ratio. This specific aspect of the strategy takes a departure from the regular option to purchase an equal number of calls and puts.
Limited Risk
To plan and implement the strategy, the investor must purchase out of the money calls and out of the money puts in a larger ratio. It is rare for an investor to go beyond the conventional ratio of This ensures that the cost of the options purchased by the investor remains at a bare minimum. Often, investors associate the act of buying an additional contract with the risk of running losses.
This is because the cost of purchasing the additional contract adds to the overall cost of the strategy.
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This means that the strategy will have to move by just as much margin in order to obtain a profit level. Thus, it will be right to say that this volatile strategy is suitable for beginners. The up front debit spread that it creates requires a low level of trading to implement the strategy. A bearish inclination to the movement of a stock price gives merit to the use of a strip strangle strategy.
Strip Options: A Market Neutral Bearish Strategy
So, after implementing the strategy, if the price of a stock was to go down by enough margin, the investor can benefit from a large quantum of profits. Although there is significant potential to make a profit even when the price of the security goes up, it is in the best interest of the investor if it goes down instead. The idea behind the strip strangle is to pick and plan the strategy at a time when the investor expects a fall in the price of the security.
Since, there are only two transactions involved, it is not cumbersome for a new investor to exercise the strategy. The only strict decision making involved in this strategy is the strike price at which the investor purchases the call and put options. Plus, the ratio in which the options are taken is also a vital factor which will determine the success of the strategy.
Options Trading Strategies: Neutral - Strip Strategy
The farther out the strike price happens to be from the actual price of the security, the more will be the margin that the price needs to move across on the date of expiry. It is a good idea to pick an equal distance between the strike prices of the call and put options.
As long as the price of a stock moves in a particular direction, the possibility to earn a profit is unlimited. The quantum of the profit will be larger if the movement of the price is on a downward trajectory. On the same hand, the risk to incur a loss has a limit on it. In fact, the maximum amount of loss that an investor can incur is not more than the amount of net debit spread. As compared to a regular strangle strategy, the profit potential in this strategy is quite high.
Plus, as compared to a strip straddle strategy, the net debit spread is also low. However, the investor needs to pump a higher than usual cash to exercise this strategy. Due to this, the quantum of loss, though limited, can be quite high. Let us take an example of a stock which is trading at INR The investor expects that the price of the security will move by a significant margin in the days to come.
More so, a downward movement in the price cannot be ruled out. Given the design of the strategy, it is not hard to see why it is suitable for a beginner. As such, there is no major planning involved, except to decide the strike prices of the options.
The investor needs to only use their estimate and assumption about the movement of the stock price to enter this strategy. They can take a position in the strategy if they expect the price of the security to fall down by a significant margin. As with a strip, the buyer of a strap has also to pay an upfront premium. But he can expect a high upside if the underlying price increases before expiry.
Here is the construction of the Strip Strategy:
The strap buyer envisages a higher probability of the market moving upwards. As with a strip, the risk to reward of a strap is beneficial to the long trader if a strong move happens. The behaviour of loss and profit is also similar to that of a strip, albeit the maximum profit happens if the market moves up, as opposed to a strip where it happens if the market moves down.
The profit of a strap at various underlying market prices can be shown as below:. He is passionate about keeping and making things simple and easy.
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