Question

Assume you have been given $400,000 CAD with access to all listed stocks, bonds, futures, and options worldwide. You can trade in options and futures, in combination with the underlying asset. Assume today is Feb 1, 2020 and you have been given $400,000 CAD fake money to trade until April 20, 2020.

Perform a strap strategy. (involves two long calls and one long put with the same strike price and maturity)

Describe the trade and provide the reason for such trade.

Please provide table and or/ graph.

Answer 1

Straps are unlimited profit, limited risk options trading strategies that are used when the options trader thinks that the underlying stock price will experience significant volatility in the near term and is more likely to rally upwards instead of plunging downwards.

Unlimited Profit Potential

Large profit is attainable with the strap strategy when the underlying stock price makes a strong move either upwards or downwards at expiration, with greater gains to be made with an upward move.

The formula for calculating profit is given below:

• Maximum Profit = Unlimited
• Profit Achieved When Price of Underlying > Strike Price of Calls/Puts + (Net Premium Paid/2) OR Price of Underlying < Strike Price of Calls/Puts - Net Premium Paid
• Profit = 2 x (Price of Underlying - Strike Price of Calls) - Net Premium Paid OR Strike Price of Puts - Price of Underlying - Net Premium Paid

Limited Risk

Maximum loss for the strap occurs when the underlying stock price on expiration date is trading at the strike price of the call and put options purchased. At this price, all the options expire worthless and the options trader loses the entire initial debit taken to enter the trade.

The formula for calculating maximum loss is given below:

• Max Loss = Net Premium Paid + Commissions Paid
• Max Loss Occurs When Price of Underlying = Strike Price of Calls/Puts

Breakeven Point(s)

There are 2 break-even points for the strap position. The breakeven points can be calculated using the following formulae.

• Upper Breakeven Point = Strike Price of Calls/Puts + (Net Premium Paid/2)
• Lower Breakeven Point = Strike Price of Calls/Puts - Net Premium Paid

Suppose XYZ stock is trading at $40 in June. An options trader implements a strap by buying two JUL 40 calls for $400 and a JUL 40 put for $200. The net debit taken to enter the trade is $600, which is also his maximum possible loss.

If XYZ stock price plunges to $30 on expiration in July, the JUL 40 calls will expire worthless but the JUL 40 put will expire in-the-money and possess intrinsic value of $1000. Subtracting the initial debit of $600, the strap's profit comes to $400.

If XYZ stock is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the two JUL 40 calls expires in the money and has an intrinsic value of $1000 each. Subtracting the initial debit of $600, the strap's profit comes to $1400.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 calls expire worthless and the strap suffers its maximum loss which is equal to the initial debit of $600 taken to enter the trade.