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

# Strap Option Trading: Payoff Functions Explained with Example

Payoff function of Strap Option position
Further to the preious article on Strap Option Trading: Explained with Example, here are the details about strap option trading:
How to construct a Strap Option Position?
A Strap Option Trading Position can be constructed by an option trader by simply buying 3 options as follows:

1) 2 * ATM Call Option

2) 1 * ATM Put Option

Please note that all the 3 options to be bought here should be on the same underlying, with the same expiry date.
Also note that all are ATM or At the money options (Want to know what is ITM, OTM, ATM in Options? See Moneyness of Options - OTM, ATM, ITM Options)

Since all three are buy positions, the net position is a Net debit as option premium should be paid for the 3 options being purchased here.
Theoretically, this is how the Strap option position will look:
Suppose that we are buying options on a stock (say IBM stock currently trading at \$50) with an ATM strike price of \$50. Assume that the call option is costing \$3.5 and Put option is worth \$4. Total cost will be \$3.5 + \$3.5 + \$4 = \$11.
The 2 call options are displayed by the TURQUOISE & DARK BLUE color graph. The PUT option is displayed by PINK colored graphs.
Also note that we are not considering the prices paid for these options as of now.

Now, let's add these various option positions together and get the YELLOW colored payoff function for the Strap option. Please note that prices are still not considered.
Finally, let's introduce the prices as well. Since we are paying a net total price of \$11 the YELLOW color payoff function will shift DOWN by 11 dollars. We now get the net BROWN payoff function as follows:
Why does the Yellow graph needs to be shifted down and why not up? Since we are paying a net amount (net outflow), this is taken as negative, hence it has to be shifted down.
 Posted by Shobhit See All Articles with