What Is a Strap?
A strap, or a long strap, is an options strategy using one put and two calls with the same strike and expiration. Traders use it when they believe a large move in the underlying asset is likely although the direction is still uncertain. All options in a strap are at the money. A strap is similar to a straddle but because there are two calls for every put, the strategy does lean bullish. A short strap would sell one put and two calls but this strategy profits when the underlying does not move.
A strap may also be referred to as a "triple option."
As with its simpler options strategy cousin, known as a straddle, a strap profits when the underlying asset makes a large move from its current price. The holder profits no matter which way the underlying moves, as long as it covers the premiums paid for the options. With a strap, however, there is a bullish bias as the holder profits twice as much from an up move. That said, the trader can still make money if the underlying falls substantially.
With a strap, the profits are unlimited but the risk is controlled. Maximum loss occurs if the underlying asset does not move at all by the time the options expire. In that case, the options become worthless and the loss is limited to the premiums paid for the three options.
How a Strap is Used
Stocks tend to be particularly volatile around news events and earnings releases. A trader who is bullish on a company in the long-term but worries that the current earnings report will be less than expected might use a strap as protection against a potential whipsaw. The profit curve for a strap is similar to that of a straddle as both hold at the money puts and calls. However, because a strap holds two calls, the slope of the profit line above the current asset price is much steeper than the slope of the profit line when the underlying asset declines.
Drawbacks of Using a Strap
A primary drawback with a strap is its upfront cost to implement. Not only must a trader purchase three options, but since they are all at the money their prices tend to be relatively high. It is possible to modify a strap somewhat to use slightly cheaper options that are somewhat out of the money. This is called a strap strangle strategy. The profit curve would be similar to a regular strangle strategy as both require an even larger move in either direction to be profitable. As with the regular strap, the profit curve on the upside is steeper than it is on the downside.