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.
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 break even to the
upside is slightly
The break even to the downside is the strike less the net debit, which is more
than the Straddle because weíve bought double the amount of calls.
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 donít want to hold onto OTM or ATM options
into the last month.
the Straddle rules but buy twice as many calls as puts in order to make an
adjustment for the Strap.
itís important to follow the entry and exit rules (as for straddles), and
psychologically 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
use this strategy if you expect a large surge upwards in the stock price.
Volatility looks low but you expect it to increase, especially when you think
there is a news event or earnings report within two weeks that will affect
is trading at $25.37 on May 10, 2011.
the August 2011 25 strike put at $1.70.
two August 2011 25 strike calls for $2.40.
is profit it the stock moves either down or up, with limited risk.
risk is the net debit of the bought puts and calls. The reward is unlimited.
even up: strike plus half of the net debit.
even down: strike minus net debit.
High volatility desired.
Of Time Decay
and accelerating in the final month before expiration, therefore close out
trade within the final month.
the stock rises, sell the calls to ensure a profit and wait for a retracement
to profit from the put.
the stock drops, sell the put to ensure a profit, and wait for a retracement to
profit from the calls
a news event, close out the position if there is a profit, or if there is no
the position by selling the puts and calls.
a reminder of the rules for trading straddles that you must also apply
Choose your preferred stock price range. Some traders choose stocks between
$20.00 and $60.00, but thatís a personal preference.
Only do a Strap on a stock that is close to making an announcement, such
as the week before an earnings report.
Buy ATM calls and puts with the expiration at least two months away, preferably
three. You can get away with four months if nothing else is available.
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.
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 donít want to be exposed to.
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 weíre looking for a pennant within the
context of an upward trend.