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

# Strip Option Trading: Payoff Functions Explained with Example

Payoff function of Strip Option position
Further to the preious article on Strip Option Trading: Explained with Example
How to construct a Strip Option Position?
A Strip Option Trading Position can be constructed by an option trader by simply buying 3 options as follows:

1) 1 * ATM Call Option

2) 2 * 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 strip option position will look:

Suppose that we are buying options on a stock 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 + \$4 + \$4 = \$11.5
The call option is displayed by the TURQUOISE color graph. The 2 PUT options are displayed by PINK and DARK BLUE colored graphs. Please note that dark blue graph is not isible because it is immediately below the PINK.
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 teh YELLOW colored payoff function for the strip 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 \$11.5 the YELLOW color payoff function will shift down by 11.5 dollars. We now get the net BROWN payoff function as follows:

 Posted by Shobhit See All Articles with