Hello friends, today, I will share with you a popular market-neutral trading strategy called the strip option strategy in the market of options. This strategy is a bit more complex than some other strategies, but it can be incredibly effective if executed correctly. The strip option strategy can also be said as the modified version of a long straddle. The basic idea behind the strip option strategy is that it is designed to protect against a potential fall in the underlying asset's price while still having the potential to profit if the price goes up. Let's dive a bit deeper into how this strategy works and how it can be used.
Benefits of using the strip option strategy:
The trader can have a huge profit potential when he applies this strategy. Traders can profit in both conditions if the price goes up and even if the price falls. The profit is more with the falling of the underlying stock price. The highest loss on this strategy is limited to the premium paid initially only.
When to use the strip option strategy?
When the traders are confident about the considerable movement in the stock price of the underlying asset, they are uncertain about the direction but expect the price to fall; in such scenarios using the strip strategy would be a good idea. For example launching a new product or service by a company can result in a success or a big failure. It can be predicted easily from the buzz in the market before launch. Thus, that's the perfect time to utilize the strip strategy.
How to enter the strip option strategy?
To enter the strip option strategy, a trader has to purchase one at-the-money call option contract and also has to purchase two at-the-money put option contracts. All these options contracts must have the same underlying asset, strike price and expiry.
Break-even point of the strip option strategy:
Upper break-even point = strike price of the call or put option + net premium amount paid initially.
Lower break-even point = strike price of a call or put option - (net premium paid initially)
How to exit from the strip strategy?
You can exit from the strategy in two different methods, as below:
Sell the call and put option contracts you have and close the position
Sell the contracts prior to expiry; it will lessen the risk on the position.
Illustration
Eg. Nifty is currently trading @ 5500. A Strip can be created by buying Call strike 5500 @ premium of 130 and buying two lots of Puts strike 5500 @ 125 respectively. Net outflow of premium is 380.
Strategy | Stock/Index | Type | Strike | Premium Inflow |
Strip | NIFTY (Lot size 50) | Buy Call | 5500 | 130 (Outflow) |
| | Sell Put - 2 Lots | 5500 | 125*2=250 (Outflow) |
The payoff schedule and chart for the above is shown below.
Payoff schedule
NIFTY @Expiry | Net Payoff (Rs.) |
5100 | 21000 |
5200 | 11000 |
5300 | 1000 |
5310 | 0 |
5400 | -9000 |
5500 | -19000 |
5600 | -14000 |
5700 | -9000 |
5800 | -4000 |
5880 | 0 |
5900 | 1000 |
6000 | 6000 |
6100 | 11000 |
In the above chart, the breakeven happens the moment Nifty crosses 5310 or 5880 and risk is limited to a maximum of 19000 (calculated as Lot Size * net premium paid).