Strip Options Strategy: In the financial markets, trading options can be quite rewarding, but it can also be difficult. Fortunately, various types of strategies are practised to be profitable in different market conditions. One such strategy to know is the Strip Options Strategy.

In this article, we shall explore the bearish biased neutral options strategy i.e., the Strip Options Strategy. We shall expand the knowledge of option strategies by understanding the working structure with an example of strip strategy.

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What is Strip Options Strategy?

The strip options strategy is a three-legged bearish market-neutral strategy designed to perform in a downtrend volatile market.

In this strategy, one ATM(at the money) call option and two ATM(at the money) put options are bought in an underlying security with the same expiration date.

This strategy is deployed when the underlying security is expected to have a big down move or an up move. But likely, the down move is more expected than the up move. Basically, the strip strategy is similar to the long straddle options strategy with minor modifications.

Working model

To deploy the strip options strategy, we need to construct legs of the required options.

The legs are:-

  • First leg:- Buy two at the money(ATM) put options strike. (Here, the strike price nearest to the spot price is selected.)
  • Second leg:- Buy one at the money(ATM) call option strike. (same strike price considered in the first leg)

Example

Let us understand the above construction clearly with an example.

Assume Nifty 50 is trading with a spot price of 19580. We believe the market is expected to have a big down move or an up move with high volatility. 

But as we are more biased about the downtrend, we shall deploy a strip options strategy. 

Here the 19580 spot price is rounded off to the nearest strike price, which is 19600.

The option legs for the assumed spot price 19580 of nifty 50 are as considered below:-

  1. Buy two lots of 19600 strike put options, in which the premium of Rs 68 is paid. As we buy two lots here, the total premium accounts for 68+68=136 Rs.
  2. Buy one lot of 19600 strike call options, in which the premium of Rs 45 is paid.

Here, the total premium is calculated as the addition of premiums paid in both the buy legs. In the above example total premium accounts to Rs.181 i.e {136+45} = 181.

The margin required to deploy this strategy will be less compared to other option strategies. As we are buying the contracts here the margin required accounts for premiums paid. 

In the above example, the total premium paid is 181, and the margin is calculated as 181 x 50(1 lot quantity) = Rs. 9050.

Maximum Profit and Maximum loss

  • The maximum profit in this strategy is unlimited. Profits increase when the price of an underlying security moves away in either direction of the strike price.
  • When the underlying security expires at the strike price the maximum loss will be the total premium paid. I.e 181 x 50(1 lot quantity)= Rs. 9050(100% of margin paid).

Breakeven points

The strategy consists of two breakeven points:-

  • Upper breakeven point = strike price + total premium.

I.e 19600+181= 19781. If the spot price moves above this point the strategy starts to make profits.

  • Lower breakeven point = strike price – (total premium / 2).

I.e 19600 – (181/2)= 19509.5. If the spot price moves below this point the strategy starts to make profits.

Payoff Chart

Strip Options Strategy Pay Off Chart

From the payoff chart, it can be understood that:-

  • If the price of an underlying security expires between the upper breakeven and the lower breakeven point, then the strategy will incur a loss.
  • If the price of an underlying security expires above or below the upper breakeven and lower breakeven point respectively, then the strategy will make profits.

Advantages

  • Profits are generated when the underlying security moves in any direction.
  • The margin requirement is less when compared to other strategies.
  • Option legs can be adjusted based on traders’ views on market moments for higher profitable ratios.

Disadvantages

  • The underlying security price must change significantly to generate profits.
  • The loss incurred is 100% of the margin required in this strategy.
  • Time decay has a negative effect on the value of options.

In Closing

Having understood the strip options strategy, we shall conclude that the strategy has a lot of scope and application when there is a big up move or down move with increased volatility.

As the theta decay has a major effect on the strategy, if the price doesn’t move in the anticipated direction, one can lose the entire premium paid.

With a better understanding of the option strategies, one can improvise the setups for good risk-reward ratios with better risk management.

Written By Deepak M

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