Before you choose to apply any options strategy or immerse fully into options trading, consider the following.
Daily Options Trading vs Options For Long Term Investors
Day options are a high-risk, high reward strategy. We mean 10 X returns (or more) are possible if you get it right. It’s also very easy to see your money vaporize if you place trades and get it all wrong. Because of the nature of accelerated (and leveraged) returns on options, daily options traders must be very careful to not ‘fat-finger’ trade orders.
Options can be a strategic part of the portfolio for long-term investors also, so learning the tricks of the trade can benefit investors whether they intend to do day trading or not.
- Single Option: What is a Single Options Strategy?
- Covered Option: What is a Covered Options Strategy?
- Course on Stock Options
- Vertical Options: What is a Vertical Options Strategy?
- Straddle: What is Straddle Option Strategy?
- Strangle: What is a Strangle Option Strategy?
- Butterfly Options Trading Strategies
- Iron Butterfly: What is an Iron Butterfly Strategy?
- Reverse Iron Butterfly, with example
- Condor: What is a Condor Options Strategy?
- What is an Iron Condor Strategy?
- Collar: What is a Collar Option Strategy?
Single Option: What is a Single Options Strategy?
A single options strategy or the single-legged strategy is the basic form of trading options. You either buy a single call option or put option or sell a single call option or put option.
What is a Long Call?
When you expect the stock price to go up before the expiration date, you buy a call option. Buying a call option makes it a ‘long call’.
What is a Long Put?
When you expect the stock price to go down before the expiration date, you buy a put option. Buying a put options makes it a ‘long put’
What is a Short Call?
When you write a call option, you are obligated to sell shares at the strike price if the option buyer exercises his or her option. Selling a call option makes this position a ‘short call’
What is a Short Put?
When you write a put option, you are obligated to buy the shares at the strike price if the option buyer exercises his or her option. Selling a put option makes this strategy a ‘short put’
Covered Option: What is a Covered Options Strategy?
A covered stock strategy is executed by writing a call option when you have the long stock position (you own 100 shares per call option you are writing) to cover it. Similarly, for put options, when you write a put option and have a ‘short’ stock position to cover the put option, it is considered a covered stock strategy
What is a Covered Call?
When you are mildly bullish or neutral on a stock, you write a covered call to earn some premium on a stock you already own. In a covered call, you write (sell) a call option against an equivalent long stock position (you own 100 shares per call option contract you write).
Long Stock Position + Short Call Option
The covered call option trading strategy is prevalent among long-term stock investors because it can reduce the loss potential on shares. It can create a stream of income on those shares so long as the stock price does not decrease too significantly, and the strategy is very easy to execute. The covered call option strategy consists of two components.
- Owning 100 shares of the stock, say AAPL currently trading at $120 (Sept 4, 2020)
- Selling one call option against the shares, with strike price $150 expiring Jan 15, 2021, for $5 (*100 = $500)
This way, if the AAPL stock stays below $150 until Jan 15, 2021, you can keep your 100 shares, and also the $500 premium you collected by selling the call option.
However, if the AAPL stock goes above $150 before Jan 15, 2021, you would have to sell your 100 shares @ $150 each to the person who exercises their option to buy the 100 shares.
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What is a Covered Put?
When you are mildly bearish or neutral on a stock, you write a covered put to earn some premium on a ‘short’ stock position you own. In a covered put, you write (sell) a put option against an equivalent ‘short’ stock position.
Short Stock Position + Short Put Option
A related concept is ‘Cash secured Put’ in which instead of having a ‘short’ stock position, you can use an equivalent amount of cash as collateral against the put option.
Vertical Options: What is a Vertical Options Strategy?
Vertical Options Strategy involves buying and selling multiple stock options (same type – either call options or put options) with the same expiration date, but different strike prices.
What is a Long Call Vertical?
In Long Call Vertical, you buy a call option with a lower strike price and simultaneously sell a call option with a higher strike price – both call options should have the same expiration date.
You create a Long call Vertical when you expect the stock price to go up before the expiration date.
What is a Long Put Vertical?
In Long Put Vertical, you buy a put option with a higher strike price and simultaneously sell a put option with a lower strike price – both the put options should have the same expiration date.
You create a Long Put Vertical when you expect the stock price to go down before the expiration date.
Bear Put Spread
Debit put spread, or a long put spread is also known as a bear put spread. Bear put spread is less risky than simple short-selling. In declining markets, bear put works modestly well.
The bear put option strategy is a strategy that profits when the stock price decreases but has a limited loss potential when the stock price increases. The bear put spread options strategy is one of the four vertical spread options strategies. Compared to short-selling 100 shares of stock, the bear put spread has limited loss potential if the stock price increases while shorting stock shares has unlimited loss potential since there’s no limit to how much a stock price can rise. This means that there is no limit to how much the loss potential can be when you simply short a stock.
The bear put spread options strategy consists of two put options transactions:
- Purchase a put option, e.g. $320 put for $5
- Sell a put option at a lower strike price. e.g. $310 for $2
The maximum loss you will bear in this example is the ($5- $2)*100 = $300.
The maximum gain you will make in this example is {($320 – $310) – ($5 – $2)}*100 = $700
What is a Short Call Vertical?
In Short Call Vertical, you sell a call option with a lower strike price and simultaneously buy a call option at a higher strike price – both the call options should have the same expiration date.
You create a Short Call Vertical when you expect the stock price to go down or stay neutral before the expiration date.
What is a Short Put Vertical?
In Short Put Vertical, you sell a put option with a higher strike price and simultaneously buy a put option with a lower strike price – both the put options should have the same expiration date.
You create a Short Put Vertical when you expect the stock price to go up or stay neutral before the expiration date.
Bull Put Spread
Bull Put Spread strategy profits when the stock price increases or remains above the put spreads strike prices as time goes on. It is a limited-risk strategy, consisting of two separate put option components.
- Sell a put option at one strike price, e.g. $350 for $10
- Buy another put option at a lower strike price, e.g. $340 for $3
The bull put spread strategy is one of the four vertical option strategies. The maximum loss of this strategy is limited: {($350-$340) – ($10 – $3)}*100 = $300 i.e. the difference between the strikes, the less credit received.
On the flip side, the maximum profit is also limited. Max profit in this example would be ($10 – $3)*100 = $700
Straddle: What is Straddle Option Strategy?
In straddle strategy, you buy or sell 1 call option and 1 put option with the same strike price and same expiration date.
What is a Long Straddle?
You create a long straddle when you believe the stock price will move significantly in one direction or another before the expiration date. A long straddle is created by simultaneously buying a call option and a put option with the same strike price and same expiration date.
Creating a long straddle is a ‘net debit’ strategy, i.e. when you create a long straddle, you have to pay some money as premium.
A long straddle has a breakeven point on either side of the stock price. The investor makes a profit if the price goes
- higher than the breakeven point on the higher side
- OR, lower than the breakeven point on the lower side.
What is a Short Straddle?
You create a short straddle when you believe the stock price will stay confined within a certain price band until the expiration date. A short straddle is created by simultaneously selling a call option and a put option with the same strike price and same expiration date.
Creating a short straddle is a ‘net credit’ strategy, i.e. when you create a short straddle, you collect some money as premium.
A short straddle has a breakeven point on either side of the stock price. The investor makes a profit if the price remains in the ‘breakeven price’ band, i.e.
- lower than the breakeven point on the higher side
- AND, higher than the breakeven point on the lower side.
Strangle: What is a Strangle Option Strategy?
Strangle strategy is similar to a Straddle Strategy. In Strangle Strategy, you buy or sell a call option and a put option of the same expiration date, but different strike prices (hence being different from a Straddle strategy).
What is a Long Strangle?
You create a long strangle when you believe the stock price will move significantly in one direction or another before the expiration date. A long strangle is created by simultaneously buying a call option and a put option with the same expiration date, but DIFFERENT strike prices.
Creating a Long strangle is a ‘net debit’ strategy, i.e. when you create a long strangle, you have to pay some money as premium.
A long strangle has a breakeven point on either side of the stock price. The investor makes a profit if the price goes
- higher than the breakeven point on the higher side
- OR, lower than the breakeven point on the lower side.
What is a Short Strangle?
You create a short strangle when you believe the stock price will stay confined within a certain price band until the expiration date. A short strangle is created by simultaneously selling a call option and a put option with the same expiration date, but DIFFERENT strike prices.
Creating a short strangle is a ‘net credit’ strategy, i.e. when you create a short strangle, you collect some money as premium.
A short strangle has a breakeven point on either side of the stock price. The investor makes a profit if the price remains in the ‘breakeven price’ band, i.e.
- lower than the breakeven point on the higher side
- AND, higher than the breakeven point on the lower side.
Read: Straddle vs Strangle Options
Butterfly Options Trading Strategies
The butterfly spread is an options strategy. It is a strategy with a fixed risk and capped profit. It is a combination of both bull and bear spreads. All butterfly spreads involve 4 option contracts for the same expiration date and use three different strike prices. The strike prices of the out-of-money option and in-the-money option are equidistant from the strike price at-the-money option (for example $110 and $90 are equidistant from $100).
What is a Butterfly Options Strategy?
A Butterfly Options Strategy is a combination of bear and bull spreads. Each Butterfly Options Strategy involves four stock options (of the same type – either 4 call options or 4 put options) with the same expiration date and THREE different strike prices. Refer to the chart below – in a butterfly spread the strike price in the middle has two positions.
Butterfly Options can be of the following types:
- Long Call Butterfly
- Short Call Butterfly
- Long Put Butterfly
- Short Put Butterfly
Cases explained for a stock trading at $100
Long Call Butterfly Options, with example
The long call butterfly spread is established by purchasing one in-the-money call option, one out-of-money call option, and selling two at-the-money call options. The long butterfly option strategy is a limited risk options strategy that consists of simultaneously buying the call spread and selling two at-the-money calls. Additionally, the strike prices for buying both calls should be equidistance to the at-the-money call option you’re selling.
For example, A stock is trading at $100 today. A Long call butterfly would look like this:
- Sell 2 * $100 call options (at-the-money)
- Buy 1 * $110 call option (out-of-money call)
- Buy 1 * $90 call option (in-the-money call)
To reiterate, all of the above options should have the same expiration date.
Short Call Butterfly Options, with example
A short butterfly spread is created by the sale of one call option at a lower strike price, the sale of another call option at a relatively higher strike price, and the purchase of two at-the-money call options.
For example, a stock is trading at $100 today. A short call butterfly would look like this:
- Buy 2 * $100 call options (at-the-money)
- Sell 1 * $110 call option (out-of-money call)
- Sell 1 * $90 call option (in-the-money call)
Long Put Butterfly Options, with example
A long put butterfly spread is created by selling 2 at-the-money put options and buying two put options – one in-the-money and one out-of-money.
For example, a stock is trading at $200 today. A long put butterfly would look like this:
- Sell 2 * $200 put options (at-the-money)
- Buy 1 * $190 put option (out-of-money put)
- Buy 1 * $210 put option (in-the-money put)
Short Put Butterfly, with example
A short butterfly spread is created by buying 2 at-the-money put options and selling two put options – one in-the-money and one out-of-money.
For example, a stock is trading at $200 today. A short put butterfly would look like this:
- Buy 2 * $200 put options (at-the-money)
- Sell 1 * $190 put option (out-of-money put)
- Sell 1 * $210 put option (in-the-money)
Iron Butterfly: What is an Iron Butterfly Strategy?
If you recall, in a ‘regular’ butterfly strategy as described above, we use four stock options of one type – either all call options or all put options. But, in an iron butterfly, we use four stock options, with a combination of 2 call options and 2 put options, with THREE strike prices, with the same expiration dates.
What is a Long Iron Butterfly?
In a Long Iron Butterfly, you BUY two stock options (one call option and one put option) at-the-money, sell one out-of-money call option, and sell one out-of-money put option. All four stock options should have the same expiration date.
What is a Short Iron Butterfly?
In a Short Iron Butterfly, you SELL two stock options (one call option and one put option) at-the-money, buy one out-of-money call option, and buy one out-of-money put option. All four stock options should have the same expiration date.
Iron Butterfly, with example
An iron butterfly spread is created by selling one at-the-money call option, selling one at-the-money put option, buying one out-of-money call option, and buying one out-of-money put option.
For example, a stock is trading at $100 today. An iron butterfly would look like this:
- Sell 1 * $100 call option (at-the-money)
- Sell 1 * $100 put option (at-the-money)
- Buy 1 * $110 call option (out-of-money call)
- Buy 1 * $ 90 put option (out-of-money put)
The maximum profit in the case of a call option is the net premium received for buying and selling these options.
The maximum possible loss is the difference between call strike prices ($110 – $100), less the net premium received for buying and selling these options.
Reverse Iron Butterfly, with example
As the name suggests, a reverse iron butterfly is created by doing the opposite of what is done to create an iron butterfly spread. It involves buying one at-the-money call option, buying one at-the-money put option, selling one out-of-money call option, and selling one out-of-money put option.
For example, a stock is trading at $100 today. A reverse iron butterfly would look like this:
- Buy 1 * $100 call option (at-the-money)
- Buy 1 * $100 put option (at-the-money)
- Sell 1 * $110 call option (out-of-money call)
- Sell 1 * $90 put option (out-of-money put)
Condor: What is a Condor Options Strategy?
A Condor Options Strategy is very similar to Butterfly Option Strategy. Condor is a combination of four stock options (of the same type – either 4 call options or 4 put options) with the same expiration date and FOUR different strike prices (hence different from a Butterfly Spread). Refer to the chart below – in a butterfly spread the strike price in the middle has two positions.
Condor Options can be of the following types:
- Long Call Condor
- Short Call Condor
- Long Put Condor
- Short Put Condor
What is an Iron Condor Strategy?
As explained in the section above, a Condor is a combination of four stock options of the same type. In an Iron Condor, we still use 4 stock options with the same expiration date and different strike prices. However, we use a combination of 2 call options and 2 put options to create an Iron Condor.
Long Iron Condor
In a Long Iron Condor, you buy one call option + one put option near the current stock price, sell one further out-of-money call option, and sell one further out-of-money put option. All four stock options should have the same expiration date.
Bear Put Spread + Bull Call Spread
Short Iron Condor
In a Short Iron Condor, you sell one call option + one put option near the current stock price, buy one further out-of-money call option, and buy one further out-of-money put option. All four stock options should have the same expiration date.
Bull Put Spread + Bear Call Spread
Collar: What is a Collar Option Strategy?
A Collar Option Strategy is used to protect you against big losses on one side, but it also limits your potential gains.
What is a Long Collar?
In a Long Collar, you own the shares of the stock, sell an out-of-money call option against it, and simultaneously buy an out-of-money put option. The call and put options must have the same expiration date.
What is a Short Collar?
In a Short Collar, you ‘short’ sell shares of the stock, sell an out-of-money put option against it, and simultaneously buy an out-of-money call option. The call and put options must have the same expiration date.
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