What are the characteristics of this option strategy?
Strip positions buy three contracts on the same underlying and the same expiry, one call and two puts, usually all at the money. That makes it a long volatility trade with a bearish tilt: it profits from a large move in either direction, but because it holds two puts against one call its net delta is negative and it gains roughly twice as much on a down move as on an equal sized up move. The premium for all three contracts is paid up front and is the most that can be lost.
Is this a bullish, bearish or neutral strategy?
A strip is always one call and two puts on the same strike and expiration, so it always carries the same bearish tilt. It is not a structure that can be flipped bullish by rearranging the legs. The mirror image, two calls and one put, is a separate strategy called the strap. What the strip shares with both is the need for a large move: it makes money in either direction, it just makes more of it on the way down.
Is this a beginner or an advanced option strategy?
The Strip option strategy is an advanced options trading strategy and is rarely recommended to beginners. This option strategy involves several risks and investors should be well versed in options trading before implementing this strategy.
In what situation will I use this strategy?
The Strip option strategy is used when you have a short-term belief about the magnitude of the underlying asset’s price, but you don’t have a strong conviction about direction of the move. This strategy is typically used when a large move in share price is expected and the risk of a sharp decline looks underpriced.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The strip has a low probability of profit and a large payoff when it works. The underlying has to move beyond one of the two breakevens before expiration, and if it does not, the entire debit paid is lost. The trader will also pay more in commissions and fees, on top of a premium that is lost in full if the trade does not go as planned.
How is this strategy affected by the greeks?
Delta, gamma, theta and vega all matter here. The three long contracts start with a net negative delta, because the two puts outweigh the single call, which is the source of the bearish tilt. Gamma is positive, so the position gets longer as the underlying falls and shorter as it rises, which is what makes a big move pay. Vega is positive, so a rise in implied volatility helps even before the underlying moves. Theta is the one that works against the trade: as three long premiums, the position bleeds value every day the underlying stands still.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The strip needs a large realised move, but buying it when implied volatility is already elevated means paying for that move in advance, which pushes both breakevens further away. The better entry is when implied volatility is low relative to the move actually expected, for instance ahead of a catalyst the market has not yet priced. Buying three contracts into an already expensive volatility regime is the most common way this trade loses money even when the direction is right.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting this strategy when the trade goes against you can be difficult, due to the fact that it involves trading multiple option contracts. It is also worth noting that when adjusting the strategy, the trader must be aware of any changes in the greeks which might affect the price of the strategy.
Where does this strategy typically fall in the range of commissions and fees?
Due to the fact that this strategy involves trading multiple options contracts, the commissions and fees associated with the strategy will likely be higher than other option strategies. However, the specific commission and fee rates depend on the broker being used.
Is this a good option income strategy?
This is not an ideal strategy to generate a steady flow of income over time as it is a net debit strategy. This strategy can be used to capture large movements in share price, without purchasing the stock. However, it is important to note that because this strategy involves trading multiple options, it carries a high degree of risk.
How do I know when to exit this strategy?
When deciding when to exit this strategy it is important to consider the position’s potential risk and reward as well as the expected return on investment. An investor should consider exiting the position if the potential reward is uncomfortably low or if the underlying asset moves significantly in either direction.
How will market makers respond to this trade being opened?
Market makers typically try to take a neutral stance when responding to trades that are opened, and will try to match the buyer and seller of options. However, they will adjust their prices as they see fit in order to remain profitable.
What is an example (with calculations) of this strategy?
For example, an investor enters into a Strip option strategy on MSFT stock with an underlying stock price of $277.50. They buy one ATM call option and two ATM put options at that strike. The net premium paid for the three contracts is $14.85 per share, or $1,485 for the position, and that $1,485 is the entire risk on the trade.
The two breakevens are not symmetric, because two puts recover the debit twice as fast as one call. On the upside the single call has to cover the whole debit, so the breakeven is $277.50 plus $14.85, or $292.35, above which the long call carries the position and the profit is uncapped. On the downside the two puts split the work, so the breakeven is $277.50 minus $7.43, or $270.08, and below it the position gains $200 per point against $100 per point on the upside. That downside gain is large but bounded, because the stock can fall no further than zero: the most the position can make on the downside is 2 x $277.50 minus $14.85, or $540.15 per share. Between $270.08 and $292.35 the trade loses, and the worst case is MSFT finishing exactly at $277.50, where all three contracts expire worthless and the full $1,485 is gone.
MarketXLS is an advanced options trading platform that can help investors easily analyze and implement options strategies such as the Strip option strategy. It has a suite of tools specifically designed for options analysis, market analysis and risk management. These tools help investors easily identify market trends and adjust their strategies quickly when necessary.
Here are some templates that you can use to create your own models
Strip Strangle
Strip Straddle
Strap Straddle
Strap Strangle
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Becoming a Pro by Knowing the Option Delta Formula
Understand What a Strangle in Options Is
Strip Straddle Options Strategy (Using MarketXLS Template)
Strap Strangle Options Strategy (Using MarketXLS Template)
Strip Strangle Options Strategy (Using MarketXLS Template)