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 are at the money.
It is similar to a straddle but because there are two puts for every call, the strategy does lean bullish.
A short strap would sell one put and two calls but this strategy profit when the underlying does not move.
Another name for a strap is a "triple option".
BREAKING DOWN Strap
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, the holder profits twice as much from an up move, but still can make money if the underlying falls substantially.
Profits are unlimited but 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.
A more thoughtful application of a strap would be when the trader expects large swings in the short-term but and eventual upside move later. If the market moves lower, the trader can sell the options. Ideally, the profit from the put compensates for the losses in the two call options.
Using a Strap
Stocks tend to be volatile around news events and earnings releases. A trader who is fairly 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.
A primary drawback with a strap is its upfront cost to implement. The trader must 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.