Strap Option Trading: Explained with Example: Options, Futures, Derivatives & Commodity Trading

Strap Option Trading: Explained with Example

Details about Strap Option Trading explained with example
This series of articles will be dedicated to explaining "Strap Option Trading".
The term "strap" is said to be a modified case of another commonly traded option combination called "Long Straddle Option Trading". One thing to note is that Strap has a BULLISH outlook for the option buyer or trader. It is called strap because of the fact that there is a kind of "skewed" payoff on the higher side price movement as compared to the downward price movements (as we will see shortly in the following section).
So basically, it means that the Starp Option Position for the Buyer is profitable on both the sides (like a straddle). The only thing is that with a strap, the trader is expecting more possibility of upward price movement as compared to downward price movement.

In which scenarios should an option trader trade Strip Option ?
An option trader can take the strip option position when he is expecting a big price move in the underlying stock or index price, but the direction of that move is not clear i.e. the expected big price movement can be either on the upside or on the downside. Till this point, the scenario is exactly similar to that of Long Straddle Option Trading.
So what differentiates the Straddle with a strap? The thing that differentiates the long straddle with a strip is that the outlook is more BULLISH on the strap option trading position while in long straddle the price movement outlook is same on both directions and typically yields similar profits on both sides for the same underlying price movements. In a strap option position, the profit is double for the same underlying price movement on the upside as compared to that on the downside.
Hence, an option trader can take strap position if there is a big price move expected but chances are more that it will be in the upward direction. This is typically the case when a big annoucement or news is expected like and earnings report announcement of a company or a project bidding results are expected depending upon which the price of the underlying stock is expected to move.

One thing to note is that constructing the strap option position will require 3 option buys, hence it costs a lot of money for paying 3 option premiums. Since this is a pure net BUY position with 3 options, it will hit hard in terms of time decay effects.
Time decay will hit this strap position in a bad way because this is a net BUY position with 3 options (See Options Time Decay: Explained with Examples).
Now, let's head on to the understanding the Strap options in more details with Strap Option Trading: Payoff Functions Explained with Example
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