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Strip-Neutral Strategy

Options-Trading-Beginners

Explanation

A strip is a bearish option trading strategy made for net debit investment and is similar to a long straddle, the only difference between a strip and long straddle is that the trader is long ontwo put options instead of one.A trader executes this strategy when he/she is holding a very bearishview on the market and expects big fall in prices of underlyingand bullish on the volatility. At the same time the trader wants to gain from the upside if the primary assumption doesn’t take off as per the expectation. This option strategy will be more profitable is the price fallingas compared to long straddle since the strategy executed 2 put options.

This option strategy entails buying at-the-money (ATM) call and twice as many at-the-money (ATM) puts of the same underlying asset, expiration date, and strike price. Strips are costly because the consumer must pay a cost premium upfront. To break even on the strip approach, the stock price must fall sufficiently to cover the cost of three long options.

The most common execution ratio of this option strategy is 1:2 (Call: Put) but the number of puts can be multiplied as per the bearishness stand of the trader.

Risk:

Limited

Reward:

Unlimited

Construction

Buy 2 ATM Put Options

Buy 1ATM Call Option

Option Type Expiry Date Strike Price LTP Action No. Of Lots
PUT 27/04/2023 42800.0 181.1 Buy 2
CALL 27/04/2023 42800.0 173.55 Buy 1

 

Max Risk Max Reward Lower Break Even Upper Break Even
535.75 Unlimited 42532.125 43335.75

 

Market Expiry Payoff 1 Payoff 2 Net Premium Option PayOff At Expiry
42000.0 1600.0 0.0 -535.75 1064.25
42100.0 1400.0 0.0 -535.75 864.25
42200.0 1200.0 0.0 -535.75 664.25
42300.0 1000.0 0.0 -535.75 464.25
42400.0 800.0 0.0 -535.75 264.25
42500.0 600.0 0.0 -535.75 64.25
42600.0 400.0 0.0 -535.75 -135.75
42700.0 200.0 0.0 -535.75 -335.75
42800.0 0.0 0.0 -535.75 -535.75
42900.0 0.0 100.0 -535.75 -435.75
43000.0 0.0 200.0 -535.75 -335.75
43100.0 0.0 300.0 -535.75 -235.75
43200.0 0.0 400.0 -535.75 -135.75
43300.0 0.0 500.0 -535.75 -35.75
43400.0 0.0 600.0 -535.75 64.25
43500.0 0.0 700.0 -535.75 164.25
43600.0 0.0 800.0 -535.75 264.25

 

Payoff Chart

 

Example

As we have already discussed above in explanation, this strategy is implemented when the trader is very bullish on the downside with upside protection. The Bank Nifty is trading at 42800 levels and the trader implements a strip option trading strategy. Total investment by the trader will be equal to the net premium paid which is Rs. 13400 ((181*2) + 174) *25

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    Scenario1:

    if at expiry the market becomes volatile but closes in opposite direction as per the trader expectation at 43500. Profit will be made on the long call which is equal to Rs. 4100 ((43500-42700-174) – (181*2))25

    Scenario 2:

    if at expiry market showed little or no volatility trader will lose all the premium paid which is equal to Rs. 13400

    Scenario3:

    if the market closes perfectly as per the trader expectation on the downside at 42000 levels, the trader would make two times profit which would be equal to Rs. 26600 ((42800-42000-181) *2 – 174) *25.

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