What Is a Strap?
A strap is an options strategy involving 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 is bullish. A strap may also be referred to as a "triple option."
A strap can be compared with a strip, which involves two puts and one call, making it a bearish straddle modification.
- A strap is an options combination that involves purchasing two at the money calls and one at the money put.
- It is essentially an ATM straddle with an additional call option, making it a bullish-leaning strategy.
- The strap strategy offers a good fit for traders seeking to profit from high volatility and underlying price movement that will still profit if the price instead goes down.
- Long-term option traders may want to avoid straps because they will incur considerable premium generated by time decay.
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. A short strap would involve selling one put and two calls but this strategy profits when the underlying does not move.
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.
The cost of constructing the strap is high because it requires three options purchases:
- Buy 2 ATM (at-the-money) call options
- Buy 1 ATM (at-the-money) put option
All three options should be bought on the same underlying security, at the same strike price and expiration date. The underlying can be any optionable security, i.e. a stock like IBM or an index like SP-500.
How Straps Are 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.
The trade has unlimited profit potential above the upper breakeven point because, theoretically at least, the price can rally to infinity. For each point gained by the underlying security, the trade will generate two profit points – i.e. a one-dollar increase in the underlying increases the payoff by two dollars.
This is where the bullish outlook for strap plays offers better profit on upside compared to the downside and how the strap differs from a straddle that offers equal profit potential on either side.
The trade has limited profit potential below the lower breakeven point because the underlying cannot drop below $0. For each point lost by the underlying, the trade will generate one profit point.
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.