In this paper, a lapped orthogonal transform adapted for local directionality of an image is proposed and its application in adaptive image coding is presented. First, we address the problem to construct the lapped orthogonal transform with short and long functions such that the long functions are twice the length of the short functions, and derive the transform with the optimal short functions in the energy compaction sense. Moreover, using the optimal solution, we propose the concept of an orientation adaptive lapped orthogonal transform (OALOT) and give its design method. Experimental results show that in addition to the property of the LOT which reduces blocking artifacts, the OALOT possesses the property of preserving strong edges and lines.