Profit with Strip Options: The Market Neutral Strategy Experts Use

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Strip options are a type of options trading strategy that allows investors to potentially profit from significant price movements in any direction, with an emphasis on downward movements. This strategy involves purchasing multiple options that hedge against volatile market swings, making it suitable for traders who anticipate heightened market volatility but are uncertain about the price direction. By using strip options, traders can capitalize on large market fluctuations with a limited risk profile, as the maximum potential loss is capped at the total premium paid. Learn how to build a strip option strategy effectively and gain insights on when to deploy it for optimal results.

How to Construct a Strip Option Strategy

The cost outlay involved in constructing the strip position can be high as it requires three at-the-money (ATM) options purchases:

1. Buy 1x ATM Call
2. Buy 2x ATM Puts

These options should be bought on the same underlying, with the same strike price and same expiry date.

Example

Assume you are creating a strip option position on a stock currently trading around $100. Since ATM options are bought, the strike price for each option should be nearest available to the underlying price; let’s take as an example $100.

Here are the basic payoff functions for each of the three option positions. The blue graph represents the $100 strike price long call option (assume $6 cost). The overlapping yellow and pink graphs represent the two long put options (costing $7 each). We’ll take the price (options premiums) into consideration at the last step.

Now, let’s add all these option positions together, to get the following net payoff function (turquoise color):

Finally, let’s take prices into consideration. Total cost will be ($6 + $7 + $7 = $20). Since all are long options (i.e., purchases), there is a net debit of $20 for creating this position. Hence, the net payoff function (turquoise plot) will shift down by $20, giving us the brown-colored net payoff function with prices taken into consideration:

Understanding Profit and Risk Scenarios in Strip Options

There are two profit areas for strip options i.e. where the brown payoff function remains above the horizontal axis. In this strip option example, the position will be profitable when the underlying price moves above $120 or drops below $90. These points are known as breakeven points as they are the “profit-loss boundary markers” or “no-profit, no-loss” points.

In general:

• Upper breakeven point = strike price of call/puts + net premium paid

= $100 + $20 = $120, for this example

• Lower breakeven point = strike price of call/puts – (net premium paid / 2)

= $100 – ($20/2) = $90, for this example

Analyzing the Profit and Risk Profile of Strip Options

Beyond the upper breakeven point (i.e., on an upward price movement of the underlying), the trader has unlimited profit potential, as theoretically the price can move to any level upwards offering unlimited profit. For every single price point movement of the underlying, the trader will get one profit point (i.e., one dollar increase in underlying share price will increase the payoff by one dollar).

Below the lower breakeven point, i.e. on a downward price movement of the underlying, the trader has limited profit potential as the underlying price cannot go below $0 (worst case bankruptcy scenario). However, for every single downward price point movement of the underlying, the trader will get two profit points.

This is where the bearish outlook for strip option offers better profit on the downside compared to the upside, and this is where the strip differs from a usual straddle which offers equal profit potential on either side.

Profit in Strip Option in the Upward Direction 

If the underlying moves up, we can compute the following:

Price of underlying – strike price of call – net premium paid – brokerage and commission

Assuming the underlying ends at $140, then profit would be:

= $140 – $100 – $20 – brokerage = $20 ( – brokerage)

Profit in Strip Option in the Downward Direction

And, if the price moves down instead, we would compute as follows:

2 x (strike price of puts – price of underlying) – net premium paid – brokerage and commission

​Assuming the underlying ends at $60, then profit would be:

= 2 ($100 – $60) – $20 – Bbokerage = $60 ( – brokerage)

The risk (loss) area is the region where the brown payoff function lies below the horizontal axis. In this example, it lies between these two breakeven points i.e. this position will be loss-making when the underlying price remains between $90 and $120.

Loss amounts will vary linearly depending upon where the underlying price is, where:

Maximum loss in strip option trading = net option premium paid + brokerage and commission

In this example, the maximum loss = $20 + brokerage

Additional Considerations for Strip Option Traders

The strip option trading strategy is perfect for a trader expecting a considerable price move in the underlying stock price, is uncertain about the direction, but also expects a higher probability of a downward price move. There may be a big price move expected in either direction, but chances are more that it will be in the downward direction.

Real-life scenarios ideal for strip option trading include the following:

• Launch of a new product by a company
• Expecting too good or too bad earnings to be reported by the company
• Results of a project bidding for which the company has placed a bid

In these cases, a product launch may be either a success or a failure, or earnings may be too good or too bad, a bid may be won or else lost by the company—all of these may lead to large price swings where one is uncertain of the direction.

The Bottom Line

The strip option strategy fits well for short term traders who will benefit from the high volatility in the underlying price movement in either direction. Long-term options traders should avoid this, as purchasing three options for the long term will lead to a considerable premium going toward time decay value, which erodes over time. As with any other short term trade strategy, it is advisable to keep a clear profit target and exit the position once the target is achieved.

Although an implicit stop-loss is already built into this strip position (due to the limited maximum loss), active strip options traders do keep other stop-loss levels based on underlying price movement and indicative volatility. The trader needs to take a call on upward or downward probability, and accordingly select strap or strip positions.