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Understand Strip Option Strategy: When, What, why, and how


We shall start with the definition of strip Strategy. It is a bearish strategy that is created by buying two put options and one call option with the same strike price. In this strategy, the bet is on volatility.


Options trading strategy offers various combinations that can give you a chance to get unlimited profit if the combinations are selected properly. Regardless of the underlying asset's price increase, decrease, or stagnation, traders can gain huge profits; one such strategy is the strip strategy. We shall discuss the strip strategy in detail in this article.


The strip is one of the types of Long straddle strategies with some slight alterations. It is a bearish Market-neutral Strategy that gives double profit when the underlying asset price moves downward or upwards. So, it is considered the best Market-neutral Strategy because it provides an equal chance of profit upon price change on either side.


When should a trader use the Strip strategy?


A trader is supposed to use this Options Trading when they believe very high price fluctuations in the market in the near future or while they are bullish on volatility factors when the market is moving at a good speed in either direction, that is the best time to apply this strategy. It is said to be a neutral to negative strategy.


How to apply this strip option strategy?


You can apply this strategy by buying one at-the-money call option and two at-the-money put options. This strategy is costly compared to the long straddle and requires high fluctuation on the downside trend.


What is the highest risk associated with Strip Option Strategy?


When the underlying asset's price closes at the strike price during the expiry, a trader can incur the highest loss in the form of the net premium paid. At-the-money options will become zero and expire worthlessly, while the premium paid to buy the call and put options will be lost. The highest loss is the Net Premium paid.


Highest profit: When the price of the underlying asset moves in either direction during the time of expiration, traders can see a significant profit. The chances of making profit doubles when the trend is downwards.


Break Even point during expiration:


Similar to the long straddle, this strategy also has two breakeven points.

  • The upper breakeven is received by adding the strike price with the premium paid.

  • The lower breakeven is received when you divide the premium paid by 2 and subtract it from the strike price.

Advantages of using the Strip Option Strategy:


As this is a neutral to bearish strategy, you can take advantage of the volatility. When the prices are low and are expected to fall more at that time, this strategy is beneficial. The loss is limited to the net premium paid only.

  • Profit can be made with the price change in any direction

  • Loss is limited.

  • A trader can make an unlimited profit if the share price is moving.

Disadvantages of the strip strategy:


as the volatility is the big positive factor; time decay affects negatively. Time factor affects the strategy in the last week of expiry. We have seen that creating the strip strategy is very costly, and if the market does not make a move as desired, a trader can lose all the premium paid to create the strip strategy.

  • This strategy is expensive.

  • The price must fluctuate to make a profit

  • May affect negatively

How to exit from this strategy?


You can exit from this strategy by two methods:

1.Close the position - Sell the call and put options you have bought

2.Mitigate the risk - Sell the position a few days before expiry.


Example:


Let us assume a trader is bearish on a stock and decides to use the strip strategy. He buys 2 ATM options (put) of Rs. 5200 by paying a premium of Rs. 85 and buys one Atm option (call) of Rs. 5200 by paying a premium of Rs 100.


Results


Scenario 1: while expiration if the stock closes at 4900, then the trader can make a profit of Rs. 16,500 [{(300-85)*2 - (100)*50}]


Scenario 2: During expiration, if the stock closes at 5200, the trader or investor will lose all the net premiums paid. As the strike price and current price are both the same, it nullifies any opportunity for profit or loss.


Scenario 3: While expiration, if the stock closes at 5400, then the trader or investor will lose Rs. 3500 [{(200-100 -(85*2)}*50]


We hope the concept of the strip strategy must be clear, and you very well know when to apply it. If you have any questions, write to us using the comment box below. We will make sure you get a satisfactory answer from our side.

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1 Comment


joty islam
joty islam
Oct 24, 2023

for example, multiplying by 50, why? I don't understand it.

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