What Is a Strap Option?

A strap option is a market neutral options trading strategy with a bullish emphasis. That means it offers profit potential regardless of the direction of the underlying security's price but more so if the market moves up.

Strap options offer unlimited profit potential on upward price movement and limited profit potential on downward price movement. The risk/loss is limited to the total option premium paid plus transaction𒆙 fees.

Strap Construction

The cost of constructing the strap is high because♔ it requires three options purchases, all at the money (ATM):

1. Buy 2 ATM call options 
2. Buy 1 ATM put option

All three options should be bought on the same underlying security at the same 澳洲幸运5开奖号码历史查询:strike price and with the same expiration date. The underlying🔯 security can be any optionable security, e.g., a stock such as IBMඣ or an index such as the S&P 500. 

Strap Payoff Function

Let's create a strap on a stock currently trading around $100. Since we're buying ATM options, the strike price for each option should be near the underlying price ($100).

The first graph below shows the basic payoff functi💯ons for each of the th🎀ree option positions.

The dark and light blue lines represent the two $100 strike price long call options ♔(costing $6.5 each). The green line represents the long put optio🍌n (costing $7).

We’ll take the price (option premiums) i🦂nto consideration at the last step.

Now, let’s add𓃲 these positions together to get the net payoff function 🌠(the black line):

Finally, let’s take prices into consideration. Total cost will be $20 ($6.5 + $6.5 + $7). Since all are long options (that is, they are purchased, not sold), there is a net debit of $20 created by this position.

Hence, the net payoff function 🙈will shift down by $20, giving us the net payoff function with prices taken into consideration (the orange line):

Strap Profit and Risk Scenarios

There are two profit areas for strap opt🎉ions where the payoff function remains above the horizontal axis.

In this example, the position will be profitable when the underlying security's price moves above $110 or drops below $80. These are known as breakeven points because they are the “profit-loss boundary markers” (also known as the “no-pro🍸fit, no-loss” points).

Upper Breakeven Point = Strike Price of Call/Puts + (Net Premium Paid/2)

= $100 + ($20/2) = $110

Lower Breakeven Point = Strike Price of Call/Puts - Net Premium Paid

= $100 - $20 = $80

Strap Profit and Risk Profile

The trade has unlimited profit potential above the upper breakeven point because, theoretically, the price can rally to infinity. For each price po🙈int gained by the underlying security, the trade will generate two profit points—i.e., a one dollar increase in the underlying security price increases the payoff by two dollars.

This is how the bullish outlook for a strap offers better profit on the upside compared to the downside and how the strap differs from🍸 a straddle, which offers equal pr♏ofit potential on either side.

The trade has limited profit potential below the lower breakeven point b💃ecause the underlying security price cannot drop below $0. For each price point lost by the underlying security, the trade will generate one profit point—i.e., a one dollar lossℱ increases the payoff by one dollar.

Profit made from price moving up = 2 x (Price of Underlying Security - Strike Price of Calls) - Net Premium Paid - Transaction Cost

Assuming that the price of the underlying security ends at $140, the profit = 2 x ($140 - $100) - $20 - Transaction Cost

Profit = $60 - Transaction Cost

Profit made from price moving down = Strike Price of Puts - Price of Underlying Security​ - Net Premium Paid - Transaction Cost

​Assuming underlying ends at $60, then profit = $100 - $60 - $20 - Transaction Cost

Profit = $20 - Transaction Cost

Risk/Loss

The riskไ-or-loss area is the region where the payoff function lies below the horizontal axis. In this example, it lies between the two breakeven points.

So the trader incurs a loss wheꦛn the underlying security price remains between $80 and $110. The loss will vary depending upon the specific underlying🍸 price.

Maximum loss in strap trading = Net Premium Paid + Transaction Cost

In our example, the maximum loss = $20 + Transaction Cost

The Bottom Line

The strap optio꧙ns strategy may be a good fit for traders seeking to profit from high volatility and underlying price♔ movement in either direction. 

As with all trading strategies, it's important to have a clear profit target and to exit the position when the target is reached.

Althoughꦡ the stop loss is already built into the position due to the limited maximum loss, traders should also keep an eye on stop-loss levels generated by underlying price movement and volatility.