Question

Why do the vast majority of sophisticated option investors use combination strategies such as straps, strangles, straddles, collars, butterfly spreads, iron condors and iron butterflies? Pick one of these combination strategies and explain specifically how it works and why you would want to use it.

Answer 1

A combination strategy is a strategy in which option investors take positions in both calls and puts on the same stock. An option investor uses a combination strategy to minimize his/her risk and to ensure that profits are earned irrespective of the fact whether the markets moves up or down. In other words investors use a combination strategy to minimize the risks that they face due to fluctuations in the direction of price movements of the underlying asset or stock.

The combination strategy that I have picked is “straps”. This strategy consists of two calls and one put and the calls and the put have the same strike as well as the same expiration. This strategy is used when traders are of the opinion that the underlying asset or stock will witness a large move in their prices, though they are not sure if the movement will be upwards (i.e. an increase) or downwards (i.e. a decrease). By using the straps combination strategy the holder will make a profit irrespective of the fact whether the price moves up or goes down.