Strip options: concept, advantages and applications

Imagine trading thousands of bags of corn, soybeans or coffee without knowing whether next week's price will plummet or skyrocket. This uncertainty is the daily reality for commodity producers and investors: volatility. Sudden price fluctuations can erode margins, jeopardize contracts and generate significant losses. 

To protect themselves, producers and investors resort to hedging tools, which act as a "shield" against price fluctuations. Among the alternatives available, one of the most efficient, but still little known, is the strip option, which offers more predictability and flexibility in managing large volumes. 

In this article, you'll find out: 

• What strip options are and how they work;
• The relationship between time, volatility and price in this type of contract;
• How call stripping and put stripping work in practice;
• The specific advantages for producers and investors.
  
  

We wish you an excellent reading! 

Strip options vs. traditional options: what's the difference? 

Strip options represent a unique approach to controlling market risk, especially for high volumes, as they offer periodic maturities. Unlike vanilla (traditional) options, which generally have a single long-term maturity, strip options divide a large volume into multiple short-term contracts. 

Time is a determining factor in the world of options. The longer the period until an option expires, the more expensive it tends to be, since the unpredictability of the price of the underlying asset increases considerably.  

In addition, planning and forecasting in the short term is simpler than in the long term. This intrinsic relationship between time and the volatility of the asset's price is fundamental to understanding the logic of strip options. 

What is the relationship between time and price in strip options? 

The relationship between time and price in strip options is straightforward: less time means greater predictability, less risk of volatility and, consequently, a lower price. This is why strip options with short maturities are more affordable than a single option with a long maturity.  

The most common timeframes used in this format are daily and weekly. This arrangement allows for a more granular and adaptable management of market conditions, which provides flexibility that traditional options do not. 

How do call and put strips work in practice? 

Call and put options are types of strip options and operate with a periodic maturity mechanism. This allows the holder to participate in market movements with limited loss, protection against rises (in the case of a call) or falls (in the case of a put). 

For a call strip, the daily or weekly observation of the price in relation to the strike determines the exercise. For a put strip, the same principle applies, but with the objective of downside protection.  

To illustrate, imagine you need to trade 1,000 bags of corn, with a final term of six months (equivalent to 24 weeks). To manage the price risk over this period, you could use a weekly strip call option. This means that each week, the company acquires the right to buy 41.6 bags of corn (1,000 ÷ 24) at a predetermined price (strike). 

Each week, the reference price is observed:  

• If it is above the strike, the call holder exercises the right to buy at the more advantageous value.  
• If it's lower, it's more advantageous to buy the corn directly on the market, as the unexercised option "turns to dust" (loses its value). 
  
  

For a strip put, the logic is the opposite: exercise is advantageous when the value is below the strike line. 

How does volume risk manifest itself in strip options? 

Volume risk appears when, at the end of the contract period, the buyer is unable to acquire the total volume expected. This scenario occurs because the exercise of the option depends on market conditions at each daily or weekly "observation".  

Take this scenario: a 56-week call strip, where only 12 weeks resulted in trading volume at the strike price. In this case, the call buyer only received 18% of the volume originally traded.  

Situations like this highlight the need to manage volume risk and, if necessary, supplement the operation to mitigate this exposure. 

How can strip options be used by producers and investors? 

Strip options allow large volumes to be traded more flexibly, reducing the exposure to long-term volatility by distributing risk over shorter maturities. This segmentation of risk is often suitable for producers and investors handling substantial volumes. 

They are also relatively cost-effective compared to traditional vanilla options, making them a practical tool for long-term operations. By spreading protection across time, strip options can help align risk management strategies with the dynamic nature of commodity markets. 

• Points to consider: Despite these characteristics, strip options come with important limitations. They may involve higher transaction costs compared to single short-term positions, and their structure requires more sophisticated monitoring and risk management. While they help mitigate long-term volatility, they do not remove market risk altogether, and strategies implemented without proper timing can still result in significant losses. 

Where can I find insights for more assertive market decisions? 

Understanding financial instruments such as strip options is an important step towards managing the volatility inherent in commodity markets. However, to make truly assertive decisions, it is essential to go beyond the tool. 

You need to follow trends, understand price movements and have access to analyses that reflect the complexity of the global scenario. In this context, having a reliable source of market intelligence is a differentiator for producers, investors and managers looking to minimize risks.  

Hedgepoint Global Markets is committed to offering this support by providing valuable materials, specialized courses and detailed analyses that can significantly boost your risk management.  

Want to deepen your understanding of market dynamics and turn volatility into real opportunity? Get to know our Hedgepoint HUB platform and check out exclusive information that can broaden your vision and help you make much more strategic decisions. 

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