Strip
Description
The Strip is a simple adjustment to the Straddle to make it more biased toward the
downside. In buying a second put, the strategy retains its preference for high volatil-
ity but now with a more bearish 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 plunging downwards. As such, our risk is greater than with the Straddle,
and our reward is still uncapped. Because we bought double the number of puts,
our position improves at double the speed, so the breakeven to the downside is
slightly tighter. The breakeven to the upside is the strike plus the net debit, which is
more than the Straddle because we’ve bought double the amount of puts.
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 don’t want to hold onto OTM or ATM options into the last month.
Use the Straddle rules but buy twice as many puts as calls in order to make an
adjustment for the Strip.
Again, it’s important to follow the entry and exit rules (as for straddles), and psy-
chologically speaking, this is another tough strategy to play after you’re in. It’s very
easy to find reasons to exit, even though it’s 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 to
strips:
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 Strip on a stock that is close to making an announcement that may
cause a surprise jump in the stock price either way, 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 stock’s 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 Strip 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 are looking for a pennant within the context of a downward trend.
P/L Profile
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