Question

Explain how to build an strip, what are the purposes of an strip strategy? Build a real life strip for a stock of your choice, pull the options contracts and paste them on the answer. Please explain each part of it, what the credit or debit will be for the transaction, include every detail of each option contract you will use to build the strip trade.

Answer 1

Please note that STRIP Option trading strategy can be considered by a trader who is expecting some movement of price of the underlying stock but with uncertainty of movement direction. However, the probability of downward movement would be higher.

In STRIP option risk or loss is limited to total premium paid for an option as well as other additional expenses such as brokerage, commission etc.

Calculation of loss:

Maximum loss: Total Premium paid for buying options + Commission

Building of STRIP option:

It involves buying of 3 options of same underlying, same strike price and same expiry date.

At The Money i.e. ATM Put Options ---- 2 lots

At The Money i.e. ATM Call Option -----1 lot

Example:

Mr. X is bearish on INDEX NDAQ and uses STRIP option, wherein he buys 2 lots of 7500.00 INDEX ATM Put Option at premium of $85.00 and also buys 1 lot of INDEX ATM Call Option at premium of $100.00

***Here, assume 1 lot is equal to 50 units*** . Therefore net debit taken to enter the trade is:

($85*2lots*50units) + ($100*50units*1lot) --> $8500.00+$5000.00 --> $13,500.00

Let us discuss scenarios at option expiry:

• Scenario 1: If, INDEX closes below 7500.00 level, for example 7200.00 level then CALL option would expire worthless and an individual would make a profit as below:

{(300-85)}*50units*2lots) - (100*50units*1lot) --> $21,500.00 – $5,000.00 --> $16,500.00

• Scenario 2: If, INDEX closes at same level of 7500.00 then there would be a loss equivalent to premium paid i.e. $13,500.00 plus additional charges such as commission, brokerage etc.

• Scenario 3: If, INDEX closes above 7500.00 level, let’s say 7700.00 then PUT option would expire worthless and there would be loss of

(85*50units*2lots) - {(200-100)}*50units*1lots) --> $8500.00-$5000.00 --> $3500.00