Monday, December 28, 2009


Strips and Straps

You can design strategies that are variations of a straddle. Strips and straps are two such variations.

A strip is a combination of two puts and one call with the same exercise price and expiration date.

A strap, one of the other hands, entails combining two calls and one put.

We assume that the exercise price for puts and calls is 100$ and that share price at expiration is 90$, 100$ or 110$. The investor would have positive pay off irrespective of the price movement, expect when the price equals the exercise price. The potential pay off would be higher under a strap strategy for share price above the exercise price.

Strangle: Combining call and put at different exercise prices

A strangle is a portfolio of a put and a call with the same expiration date but with different exercise prices.

The investor with combine an out of the money call with an out of the money put. That is, he will buy a call with an exercise price higher than the underlying share’s current price and a put with an exercise price lower than the underlying share’s current price. The effect of this strategy is similar to the effect of a straddle expect that the pay off range will be larger.

Spread: Combining put and calls at different exercise prices

The put and call options on the same share may have different exercise prices, and an investor may combine them. A spread is a combination of a put and a call with different exercise prices.

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