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ISSN: 2167-0234
Journal of Business & Financial Affairs
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A Study on Strap Option Combination Strategy

Suresh AS*

Assistant Professor, MBA Department, Dayananda Sagar College of Engineering, Kumara Swami Layout, Bangalore, India

*Corresponding Author:
Suresh AS
Assistant Professor, MBA Department
Dayananda Sagar College of Engineering
Kumara Swami Layout, Bangalore-560078, India
Tel: 91-9900145707
E-mail: [email protected]

Received December 15, 2014; Accepted February 02, 2014; Published February 15, 2015

Citation: Suresh AS (2015) A Study on Strap Option Combination Strategy. J Bus Fin Aff 3:131. doi:10.4172/2167-0234.1000131

Copyright: © 2015 Suresh AS. This is an open-access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.

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Abstract

Options are considered risky for investors and speculators due to fluctuation in the direction of price movements. An investor has to face the risk of profits where it may be extremely high or loss, here investors fail in choosing profitable options. The study is made to minimize the risk of investors by using straps option combination strategy in choosing profitable investment strategy and to know how the option combination strategy would be profitable when market moves up or down. The study has considered the securities of both increasing and decreasing prices, so that it would be possible to give suggestions for investors that how in both cases they can make profits.

Keywords

Options; risk; Speculators

Introduction

Spreads involve taking positions in call or put options only. Combinations represent option trading strategies which involve taking position in both calls and puts on the same stock. Important combination strategies include straddles, strips, straps, and strangle. The study is particularly on the combination strategy “straps”.

Straps

A strap consists of a long position two calls, one put with the same strike price and expiration date. In a strap the investor is also betting there will be a big stock price move. However, in that case an increase in stock price is considered to be more likely. In options market when an investor sign a contract, on the expiration date if the option signed is a call option, he will exercise the contract if the current market price of the underlying asset is more than the strike price of the contract and he will make profits and if the current market price of the underlying asset is less than the strike price then he will not exercise the contract and he will make losses. Similarly on the expiration date if the option signed is a put option, he will exercise the contract if the current market price of the underlying asset is less than the strike price of the contract and he will make profits and if the current market price of the underlying asset is more than the strike price then he will exercise the contract and he will incur losses.

So in both the cases the profit and losses are unlimited and this is the high risk factor for any investor and he cannot forecast whether he will make profits or loss. Here comes the benefit of using combinations of options such as ‘straps’. When investor uses straps in his options contract he will either exercise both call and put or he won’t exercise both the options. This enables the investor to incur the minimum loss that is what the premium he paid for the contract and his profits will be the maximum always and also the profit will keep on increasing as the underlying asset value increases since the combination has two call options. Figure 1 shows the illustration of profits in case of straps option combination. Here we can see that the profit decreases in the beginning for lower values of underlying assets but it always has a limited value and once it reaches that level and the asset value keep increasing the profit also increases but do not have any limited value and thus investor can make unlimited profits [1].

business-financial-affairs-benefit-illustrations-Straps

Figure 1: Benefit illustrations of Straps.

The study on the topic is made at Reliance Securities Limited. The company has allowed the study to fulfil its marketing and advertising objectives. The topic of the study is been allowed as they can use this study to give their investors an idea about how to trade in options markets, how to use options combinations and also to suggest them to take positions based on the market situations. During this study there existed a bullish market for which “straps” option combination is most suitable as it involves two call options and thus the company expects that its investors may show interest in options trading. This study may be used by the company to give reference for its investor and also give suggestions for its investors in option combinations trading.

In this study the stock index options are considered. In India the stock index options are the European options. A European option contract may be exercised only on the contract expiration date (if the option is exercised by the holder). The expiration date and the exercise date must, therefore be the same. In India expect stock options rests of the options are American type of options. The time period of the options contracts assumed for the study is three months and the option will be exercised on the last day [2]. And the benefit illustration for the investor is made by assuming the future market price of the securities on the expiration date and the price of the options are taken on the day when the contract is signed that is the first day of three month time period.

Construction of Straps for Selected Banking Sector

Yes Bank

Long Straps

1. Investor’s position: Long

2. Option type: European stock option

3. Strategy: Long Straps – Buy 2 Call and 1 Put

4. Call price: 27

5. Put price: 34

6. Net premium: (2*-27) + (-34)=-88

Interpretation: Figure 2 and Table 1 shows the net profit for the investor in straps option combination strategy in long position for the stocks of ‘Yes bank’. It says that the loss for the investor in long straps option strategy is limited (-88) and the profit is unlimited [3].

business-financial-affairs-net-payoff-long-yes-bank

Figure 2: Net payoff of long straps for Yes bank.

S0 (possible prices) E(exercise price) P(net premium) Long call payoff Long put payoff Net payoff
302.75 443.2 -88 NE 140.45 52.45
345.2 443.2 -88 NE 98 10
362 443.2 -88 NE 81.2 -6.8
410.35 443.2 -88 NE 32.85 -55.15
443.2 443.2 -88 0 0 -88
468.4 443.2 -88 50.4 NE -37.6
495.47 443.2 -88 104.54 NE 16.54
545.55 443.2 -88 204.7 NE 116.7
547.3 443.2 -88 208.2 NE 120.2

Table 1: Net payoff of long straps for Yes bank.

Short Straps

1. Investor’s position: Short

2. Option type: European stock option

3. Strategy: Short Straps – Sell 2 Call and 1 Put

4. Call price: 27

5. Put price: 34

6. Net premium: (2*27) + 34=88

Interpretation: Figure 3 and Table 2 shows the net profit for the investor in straps option combination strategy in short position for the stocks of ‘Yes bank’. It says that the profit for the investor in short straps option strategy is limited (88) and the loss is unlimited [4].

business-financial-affairs-net-payoff-short-yes-bank

Figure 3: Net payoff of short straps for Yes bank.

S0 (possible prices) E(exercise price) P(net premium) Short call payoff Short put payoff Net payoff
302.75 443.2 88 NE -140.45 -52.45
345.2 443.2 88 NE -98 -10
362 443.2 88 NE -81.2 6.8
410.35 443.2 88 NE -32.85 55.15
443.2 443.2 88 0 0 88
468.4 443.2 88 -50.4 NE 37.6
495.47 443.2 88 -104.54 NE -16.54
545.55 443.2 88 -204.7 NE -116.7
547.3 443.2 88 -208.2 NE -120.2

Table 2: Net payoff of short straps for Yes bank

Automobile Sector

Tata motors

Long Straps

1. Investor’s position: Long

2. Option type: European stock option

3. Strategy: Long Straps – Buy 2 Call and 1 Put

4. Call price: 22

5. Put price: 25

6. Net premium: (2*-22) + (-25)=-69

Interpretation: Figure 4 and Table 3 shows the net profit for the investor in straps option combination strategy in long position for the stocks of ‘Tata motors’. It says that the loss for the investor in long straps option strategy is limited (-69) and the profit is unlimited [5].

business-financial-affairs-net-payoff-long-tata

Figure 4: Net payoff of long straps for Tata motors.

S0 (possible prices) E (exercise price) P (net premium) Long call payoff Long put payoff Net payoff
387.3 423.6 -69 NE 36.3 -32.7
388.85 423.6 -69 NE 34.75 -34.25
389 423.6 -69 NE 34.6 -34.4
403.15 423.6 -69 NE 20.45 -48.55
423.6 423.6 -69 0 0 -69
430.1 423.6 -69 13 NE -56
436.7 423.6 -69 26.2 NE -42.8
449.85 423.6 -69 52.5 NE -16.5
456.6 423.6 -69 66 NE -3

Table 3: Net payoff of long straps for Tata motors.

Short Straps

1. Investor’s position: Short

2. Option type: European stock option

3. Strategy: Short Straps – Sell 2 Call and 1 Put

4. Call price: 22

5. Put price: 25

6. Net premium: (2*22) + (25)=69

Interpretation: Figure 5 and Table 4 shows the net profit for the investor in straps option combination strategy in short position for the stocks of ‘Tata motors’. It says that the profit for the investor in short straps option strategy is limited (69) and the loss is unlimited.

business-financial-affairs-net-payoff-short-tata

Figure 5: Net payoff of short straps for Tata motors.

S0 (possible prices) E (exercise price) P (net premium) Short call payoff Short put payoff Net payoff
387.3 423.6 69 NE -36.3 32.7
388.85 423.6 69 NE -34.75 34.25
389 423.6 69 NE -34.6 34.4
403.15 423.6 69 NE -20.45 48.55
423.6 423.6 69 0 0 69
430.1 423.6 69 -13 NE 56
436.7 423.6 69 -26.2 NE 42.8
449.85 423.6 69 -52.5 NE 16.5
456.6 423.6 69 -66 NE 3

Table 4: Net payoff of short straps for Tata motors.

IT Sector

Infosys

1. Investor’s position: Long

2. Option type: European stock option

3. Strategy: Long Straps – Buy 2 Call and 1 Put

4. Call price: 26

5. Put price: 32

6. Net premium: (2*-26) + (-32)=-84

Interpretation: Figure 6 and Table 5 shows the net profit for the investor in straps option combination strategy in long position for the stocks of ‘Infosys’. It says that the loss for the investor in long straps option strategy is limited (-84) and the profit is unlimited [6].

business-financial-affairs-net-payoff-long-infosys

Figure 6: Net payoff of long straps for Infosys.

S0 (possible prices) E (exercise price) P (net premium) Long call payoff Long put payoff Net payoff
3798.25 3235.15 -84 1126.2 NE 1042.2
3671.3 3235.15 -84 872.3 NE 788.3
3296.05 3235.15 -84 121.8 NE 37.8
3263.9 3235.15 -84 57.5 NE -26.5
3235.15 3235.15 -84 0 0 -84
3175.6 3235.15 -84 NE 59.55 -24.45
3067.35 3235.15 -84 NE 167.8 83.8
3053.2 3235.15 -84 NE 181.95 97.95
3050.9 3235.15 -84 NE 184.25 100.25

Table 5: Net payoff of long straps for Infosys.

Short position

1. Investor’s position: Short

2. Option type: European stock option

3. Strategy: Short Straps – Sell 2 Call and 1 Put

4. Call price: 26

5. Put price: 32

6. Net premium: (2*26) + (32)=84

Interpretation: Figure 7 and Table 6 shows the net profit for the investor in straps option combination strategy in short position for the stocks of ‘Infosys’. It says that the profit for the investor in short straps option strategy is limited (84) and the loss is unlimited.

business-financial-affairs-net-payoff-short-infosys

Figure 7: Net payoff of short straps for Infosys.

S0 (possible prices) E (exercise price) P (net premium) Short call payoff Short put payoff Net payoff
3798.25 3235.15 84 -1126.2 NE -1042.2
3671.3 3235.15 84 -872.3 NE -788.3
3296.05 3235.15 84 -121.8 NE -37.8
3263.9 3235.15 84 -57.5 NE 26.5
3235.15 3235.15 84 0 0 84
3175.6 3235.15 84 NE -59.55 24.45
3067.35 3235.15 84 NE -167.8 -83.8
3053.2 3235.15 84 NE -181.95 -97.95
3050.9 3235.15 84 NE -184.25 -100.25

Table 6: Net payoff of short straps for Infosys.

Suggestions and Recommendations

1. From the study it is found that an investor can manage his profit and losses in option combinations by taking appropriate position in the market.

2. It is found that it is the ‘long’ position in the market which always gives the investor minimum loss and maximum profits possible (Table 7).

3. Yes bank gave minimum loss of 88 and unlimited profits.

4. Tata motors gave minimum loss of 69 and unlimited profits.

Company Name Straps position Profit Loss
Banking Sector
Yes bank Long straps Unlimited profit Limited loss of 88
Short straps Limited profit of 88 Unlimited loss
Automobile Sector
Tata motors Long straps Unlimited profit Limited loss of 69
Short straps Limited profit of 69 Unlimited loss
IT Sector
Infosys Long straps Unlimited profit Limited loss of 84
Short straps Limited profit of 84 Unlimited loss

Table 7: Long Strap and short strap (Compilation of the result).

Conclusion

Investing in stock options market is always associated with a risk factor which may be low or high and has got no exact predictions that would work out. This makes the investor to stay away from investing in options. The study made shown that it is easier to make profits in options market. The only thing that the investor should be aware of is that which position he should take based on the market conditions. From the study made we can say that it is the long position in the market which gives the investor always profits and if losses are there it will be always the minimum [7]. And investor need not to be worried about the increasing or decreasing prices of stock, as we came to know from the study in both cases the investor would make the profit in long position. Though the study concentrates on four industrial sectors, it can be suggested or referred for any other sectors also and thus the study is useful for the speculators and also organizational investors for reference for investing in option combinations [8].

References

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