Strip and Strap

Strip: A strip is delta negative trading strategy. Being delta negative implies that the value of the strip position increases when the price of the underlying security goes down.

A strip is constructed by adding an extra put leg to a long straddle. So, it consists of two at the money put options and one at the money call option.

The buyer of a strip has to pay a cost premium upfront, but he expects the market to make a move in one direction before the expiry. He expects the probability of a down move to be more than that of an up move.

The risk to reward of a strip is beneficial to the long trader if a strong move happens. The maximum loss is limited to the premium paid up front, while maximum profit is unlimited.

The profit of a strip at various underlying market prices can be shown as below:

Strip

Strap: As opposed to a strip, a strap is a delta positive trading strategy. The strategy pays off more if the market moves in the upwards direction.

A strap can be constructed by adding an extra call leg to a normal straddle position. So, it consists of one at the money put option and two at the money call options.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. 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:

Strap

References:

Book:

Options, Futures and Other Derivatives by John C Hull


What’s your view on this? Share it in comments below.

Leave a Reply