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A regular strangle is a direction-neutral strategy that may be appropriate for a trader who has no idea which way the underlying security will move. But what of the trader who has a preference, whose bias is, say, toward the long side? How can he tailor-make a trade to account for his preferences?
It was for precisely this reason that the creator-of-all-things-options made the “strap strangle.”
The strap strangle is a modified version of the traditional strangle that sees the trader purchase his calls and puts in a ratio, rather than just one of each. In most cases, this will entail buying two out-of-the-money calls and a single out-of-the-money put. The ratios can be changed according to the trader’s preferences, of course, but one should be aware that the greater the number of options purchased, the farther the underlying will have to travel to generate a profit.
The Danger of Spending on Options
The greatest weakness of the strap strangle strategy resides in the cost of purchasing a number of long options (at least three). Without any offsetting short sale, the cost of the trade often overwhelms the distance traveled by the underlying, creating a net loss when all is said and done.
Let’s have a look at a genuine trading example to better understand the details.
This is a chart of Visa (NYSE: V) for roughly five months:
While Visa stock traded sideways, you did your research and determined that a breakout would be forthcoming, coincident with the release of the company’s upcoming earnings report.
The move could go either way, of course, but your facts led you to believe that a push higher was more likely, and so you sought out an appropriate options trade to fit your bias.
You settled on a strap strangle because it was a known risk/unlimited reward proposition that would make you a winner either way – but all the more so if your bullish hunch was right.
So, toward the end of April, with the stock trading at exactly $67, you made your purchases (red circle). You bought two July 70 calls for $2 each and one July 64 put for the same $2. Your total debit up front was $6.
The stock continued in its range until just days before the release. Then, things started bubbling. The shares began trending strongly higher, breaking out of their range and putting your two call options into the money.
On the day of the report, the stock gapped substantially higher, and as that was also options expiry day, you scored yourself a perfectly timed profit bonanza.
Final Calculation
The shares closed at $75 exactly, putting your two long calls each $5 in the money, while the solo put expired worthless.
Your total haul on the trade was thus a sweet $400 ([$5 + $5 – $6] x 100).
And that’s where it ended.
It should be pointed out, however, that a similar downside move would not have produced the same result. Break-even levels for the strap strangle are asymmetrical, due to the ratios involved.
On the downside, the break-even for the trade arrives at $58, which is the put strike (64) minus initial premium spent (6). On the upside, a mere move to $73 would have sufficed to make money. The upside break-even calculation is: call strike plus initial premium spent/2. In this case, it’s calculated as follows: (70 + [6/2]).
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