Strip Straddle

We class the strip straddle as a volatile options trading strategy, because it's best used when you are expecting a significant move in the price of a security. However, while most strategies of this type are specifically designed to be used when you have nothing to suggest in which direction the price of the security will move, this one is designed to be used when your volatile outlook has a bearish inclination. This means that you think a big drop in the price of the underlying security is more likely than a big increase.

The strip straddle is really just an extension of the long straddle with one modification; you buy a higher number of puts than calls. Below we have provided a brief overview of this strategy, but we would suggest that you are familiar with the long straddle before studying this strategy. If you are not yet fully aware of how it works, please read this page first.

The Key Points

Volatile Strategy (with bearish inclination)
Suitable for Beginners
Two Transactions (buy calls and buy puts)
Debit Spread (upfront cost)
Is also known simply as the Strip
Low Trading Level Required

When & How to Use a Strip Straddle

We have already stated that the strip straddle is an options trading strategy designed to be used when your outlook is volatile with a bearish inclination. Therefore you would use it when you are expecting a big movement in the price of the underlying security and, although not entirely sure in which direction, you think a downward movement is more likely than upward one. It can profit from a big movement in either direction, but will make higher profits from a downward movement.

Applying the strip straddle is very similar to applying the long straddle, in that you buy at the money calls and at the money puts. The only real difference is that you need to buy a higher number of puts than calls. You still need to use the same expiration date for both the calls and the puts.

The main decision you need to make is what ratio of puts to calls you use. As a starting point we would suggest using a 2 to 1 ratio, but you can adjust this as you see fit.

Example of the Strip Straddle

Below we have provided an example of how the strip straddle can be applied. For the sake of simplicity we have used rounded figures rather than exact market data and we've ignored commission costs.

Company X stock is trading at $50, and you believe the price will make a significant move, most likely in a downward direction.
At the money calls (strike $50) are trading at $2. You buy 1 contract (containing 100 options), at a cost of $200. This is Leg A.
At the money puts (strike $50) are trading at $2. You buy 2 contracts, at a cost of $400. This is Leg B.
You have created a strip straddle at a cost of $600.
If Company X stock is still trading at $50 by the time of expiration, then the options in both legs will expire worthless and you will lose your initial investment of $600.
If Company X stock is trading at $53 by the time of expiration, then the calls in Leg A will be worth $3 each ($300 total) while the puts in Leg B will expire worthless. The $300 value of the calls will partially offset the $600 initial investment for a total loss of $300.
If Company X stock is trading at $57 by the time of expiration, then the calls in Leg A will be worth $7 each ($700 total) while the puts in Leg B will expire worthless. The $700 value of the calls is greater than the $600 initial investment and you will have made a $100 profit overall.
If Company X stock is trading at $47 by the time of expiration, then the calls in Leg A will expire worthless while the puts in Leg B will be worth $3 each ($600 total). The $600 value of the puts will offset the $600 initial investment and you will break even.
If Company X stock is trading at $43 by the time of expiration, then the calls in Leg A will expire worthless while the puts in Leg B will be around $7 each ($1400 total). The $1400 value of the puts is greater than the $600 initial investment and you will have made an $800 profit overall.

Profit, Loss & Break-Even Calculations

The following apply to the strip straddle strategy.

Maximum profit is unlimited and profit is made when “Price of Underlying Security > (Strike + Price of Each Option in Leg A + (Price of Each Option in Leg B x Ratio of Puts to Calls))” or when “Price of Underlying Security < (Strike – Price of Each Option in Leg A - (Price of Each Option in Leg B / Ratio of Puts to Calls))”
The strip straddle has an upper break- even point and a lower break-even point.
Upper Break-Even Point = “Strike + Price of Each Option in Leg A + (Price of Each Option in Leg B x Ratio of Puts to Calls)”
Lower Break-Even Point = “(Strike– Price of Each Option in Leg A) – (Price of Each Option in Leg B / Ratio of Puts to Calls Options)”
The strip straddle will return a loss if “Price of Underlying Security < Upper Break-Even Point and > Lower Break-Even Point”
Maximum loss is limited to the initial investment and occurs when “Price of Underlying Security = Strike”

Summary

The strip straddle is a slightly more complicated strategy than the other basic trading strategies for a volatile outlook, but it's still simple enough to make it suitable for beginner traders. It's a great alternative to the long straddle if you believe that the price of the underlying security is more likely to break out to the downside than the upside.

There are only two transactions involved, so the commissions aren't particularly high, and there are no margin requirements.