Strap
Description
The Strap is a simple adjustment to the Straddle to make it more biased to the
upside. In buying a second call, the strategy retains its preference for high volatility
but now with a more bullish slant.
As with the Straddle, we choose the ATM strike for both legs, which means the
strategy is expensive. We are therefore requiring a pretty big move, preferably with
the stock soaring upwards. As such, our risk is greater than with the Straddle, and
our reward is still uncapped. Because we bought double the number of calls, our
position improves at double the speed, so the breakeven to the upside is slightly
tighter. The breakeven to the downside is the strike less the net debit, which is more
than the Straddle because we’ve bought double the amount of calls.
Again the same challenges apply regarding Bid/Ask Spreads and the psychology
of the actual trade. Remember that time decay hurts long options positions because
options are like wasting assets. The closer we get to expiration, the less time value
there is in the option. Time decay accelerates exponentially during the last month
before expiration, so we dont want to hold onto OTM or ATM options into the last
month.
Use the Straddle rules but buy twice as many calls as puts in order to make an
adjustment for the Strap.
Again, it’s important to follow the entry and exit rules (as for straddles), and psy-
chologically speaking, its another tough strategy to play after you are in. Its very
easy to find reasons to exit, even though its in breach of your trading plan. But you
must remember that you got in for a certain reason (or reasons), and you must stay
in until one of your other reasons compels you to exit.
Here’s a reminder of the rules for trading straddles that you must also apply for
straps:
1. Choose your preferred stock price range. Some traders choose stocks between
$20.00 and $60.00, but that’s a personal preference.
2. Only do a Strap on a stock that is close to making an announcement, such as
the week before an earnings report.
3. Buy ATM calls and puts with the expiration at least two months away, prefer-
ably three. You can get away with four months if nothing else is available.
4. The cost of the Straddle should be less than half of the stocks recent high less
its recent low. By recent, we mean the last 40 trading days for a two-month
Straddle, the last 60 trading days for a three-month Straddle, or the last
80 days for a four-month Straddle. The point here is that the cost of the
Straddle should be low in comparison with the potential of the stock to
move. If this works with the Straddle, then the Strap can be acceptable.
5. Exit within two weeks after the news event occurs. Never hold into the final
month before expiration. During the final month, your options will suffer
increasing time decay, which we don’t want to be exposed to.
6. Try to find a stock that is forming a consolidation pattern, such as a flag or
pennant, or in other words where the stock price action has become tighter
and where volatility has shrunk in advance of a big move in either
direction. Typically we’re looking for a pennant within the context of an
upward trend.
P/L Profile
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