<p>An option strategy refers to purchasing and/or selling a combination of options and the underlying assets in order to achieve a desired payoff. Option strategies can be created to favor different market conditions such as, bullish, bearish or neutral. The options positions consist of long/short put/call option contracts.</p>
<p>Depending on the need and market forecast, different strategies can be implemented. Bullish strategies are implemented when the market outlook is bullish. Similarly bearish/neutral strategies are implemented when the market outlook is bearish/neutral. The most commonly used strategies are listed below:</p>
<h3><strong>Covered Strategies</strong></h3>
<p>Covered strategies involve taking a position in the option and the underlying.</p>
<ul>
<li><strong>Covered Call:</strong> This strategy involved being long the underlying stock and short a call option on the same stock.</li>
</ul>
<ul>
<li><strong>Covered Put:</strong> This involves selling a put option and being short an equivalent amount of the underlying stock.</li>
</ul>
<ul>
<li><strong>Protective Put:</strong> A protective put involves buying an underlying stock and at the same time buying a put option on the same stock.</li>
</ul>
<h3><strong>Spread Strategies</strong></h3>
<p>Spread strategies involve taking a position in two or more options of the same type (A spread)</p>
<ul>
<li><strong>Bull Spread: </strong>Bull spread strategy can be created with both call and put options. A bull call spread involves buying a call option with a low exercise price, and selling another call option with a higher exercise price. Both calls will have the same underlying security and expiration month.</li>
</ul>
<ul>
<li><strong>Bear Spread: </strong>A bear call spread involves buying call options of a certain strike price and selling the same number of call options of lower strike price (in the money). Both calls will have the same underlying security and expiration month.</li>
</ul>
<ul>
<li><strong>Box Spread:</strong> A box spread is created by a combination of a bull call spread and a bear put spread with identical expiry dates. This strategy provides minimum risk.</li>
</ul>
<ul>
<li><strong>Butterfly Spread: </strong>A butterfly spread is created by using 4 option positions. A long butterfly spread is implemented as follows:</li>
</ul>
<ol>
<li>
<ol>
<li>Long 1 call a high strike price</li>
<li>Short 2 calls at an intermediate strike price</li>
<li>Long 1 call at a low strike price</li>
</ol>
</li>
</ol>
<p style="padding-left: 60px;">The strikes are equidistant.<strong><br /></strong></p>
<ul>
<li><strong>Calendar Spread: </strong>A calendar spread involves simultaneous purchase of a call option expiring in a particular month and the sale of the identical option expiring in another month.</li>
</ul>
<h3><strong>Combination Strategies</strong></h3>
<p>Take a position in a mixture of calls &amp; puts (A combination)</p>
<ul>
<li><strong>Straddle:</strong> A long straddle involves buying one call and one put option at the same strike. Similarly a short straddle involves selling one call and one put option at the same strike.</li>
</ul>
<ul>
<li><strong>Strip and Strap:</strong> A strip involves combining one long call with two long puts. A strap involves combining two long calls with one long put.</li>
<li><strong>Strangle:</strong> A long strangle involves buying one call option and buying one put option at a lower strike. Similarly a short strangle involves selling one call option and one put option at a lower strike.</li>
</ul>

Types of Option Strategies

This strategy involved being long the underlying stock and short a call option on the same stock. The long position in the underlying stock provides a cover, in case the buyer of the call option exercises his right and the stocks have to be delivered. If the trader buys the underlying instrument at the same time as he sells the call, the strategy is often called a "buy-write" strategy.

<strong>Covered Call Construction</strong>: Long 100 stocks + Short call option

<strong>Market Outlook:</strong> This strategy is useful if the investor has a neutral to slightly bullish market outlook.

<strong>Risk:</strong> Limited, but substantial. Risk arises from a fall in stock price.

<strong>Reward: </strong>Limited. Wring the call generates income from premium. If the stock price remains stable or increases, then the writer will be able to keep this premium as profit. In addition to the premium, the strategy's profit also includes a paper gain if the underlying stock price rises, up to the strike price of the call option sold.

<strong>Break Even Point:</strong> Starting stock price minus premium received
<h3>Example</h3>
An investor has 100 shares of ABC stock, valued at $10,000. He sells 1 call option contracts (in the US, 1 option contract covers 100 shares) for $300 with a strike price of $105. The payoff from the strategy can be shown as follows:
<table width="221" border="0" cellspacing="0" cellpadding="0">
<tbody>
<tr>
<td valign="bottom" width="111">Stock Price at Option Expiry</td>
<td valign="bottom" width="111">Position Profit / (Loss) at Expiry</td>
</tr>
<tr>
<td valign="bottom">90.00</td>
<td valign="bottom">(700.00)</td>
</tr>
<tr>
<td valign="bottom">92.00</td>
<td valign="bottom">(500.00)</td>
</tr>
<tr>
<td valign="bottom">94.00</td>
<td valign="bottom">(300.00)</td>
</tr>
<tr>
<td valign="bottom">96.00</td>
<td valign="bottom">(100.00)</td>
</tr>
<tr>
<td valign="bottom">98.00</td>
<td valign="bottom">100.00</td>
</tr>
<tr>
<td valign="bottom">100.00</td>
<td valign="bottom">300.00</td>
</tr>
<tr>
<td valign="bottom">102.00</td>
<td valign="bottom">500.00</td>
</tr>
<tr>
<td valign="bottom">104.00</td>
<td valign="bottom">700.00</td>
</tr>
<tr>
<td valign="bottom">106.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">108.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">110.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">112.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">114.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">116.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">118.00</td>
<td valign="bottom">800.00</td>
</tr>
<tr>
<td valign="bottom">120.00</td>
<td valign="bottom">800.00</td>
</tr>
</tbody>
</table>
<p style="text-align: center;"><img class="size-full wp-image-1280 aligncenter" title="covered_call" alt="" src="https://financetrain.com/wp-content/uploads/2010/11/covered_call.gif" width="534" height="366" /></p>

Option Strategies: Covered Call

This strategy involves selling a put option and being short an equivalent amount of the underlying stock.

<strong>Covered Put Construction</strong>: Short 100 stocks + Short put option

When the stock drops, the put option will be exercised and the investor will get the stock at the short put strike price. This will cover the obligation of the shorted shares. The investor keeps the premium received from selling the put option. If the stock rises the investor still keeps the premium, but the put option will expire worthless. The investor is still holding the short stock obligation and could sustain a loss to close the short position.

<strong>Market Outlook:</strong> This strategy is useful if the trader has a neutral to slightly bearish market outlook. This is because the trader is expecting the stock to go down or stay neutral

<strong>Risk:</strong> Maximum loss is unlimited. Since the trader is short the stock, he is at risk if the stock price rises. The maximum loss for the covered put options strategy is unlimited as the stock prices can rise infinitely.

<strong>Reward: </strong>Limited. Profit for the covered put option strategy is limited and maximum gain is equal to the premiums received for the options sold.

<strong>Break Even Point:</strong> Sale Price of Underlying + Premium Received
<h3>Example</h3>
An investor is short 100 shares of ABC stock, valued at $10,000. He sells 1 put option contracts (in the US, 1 option contract covers 100 shares) for $300 with a strike price of $97. The payoff from the strategy can be shown as follows:
<table width="221" border="0" cellspacing="0" cellpadding="0">
<tbody>
<tr>
<td valign="bottom" width="111">Stock Price at Option Expiry</td>
<td valign="bottom" width="111">Position Profit / (Loss) at Expiry</td>
</tr>
<tr>
<td valign="bottom">90.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">91.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">92.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">93.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">94.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">95.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">96.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">97.00</td>
<td valign="bottom">600.00</td>
</tr>
<tr>
<td valign="bottom">98.00</td>
<td valign="bottom">500.00</td>
</tr>
<tr>
<td valign="bottom">99.00</td>
<td valign="bottom">400.00</td>
</tr>
<tr>
<td valign="bottom">100.00</td>
<td valign="bottom">300.00</td>
</tr>
<tr>
<td valign="bottom">101.00</td>
<td valign="bottom">200.00</td>
</tr>
<tr>
<td valign="bottom">102.00</td>
<td valign="bottom">100.00</td>
</tr>
<tr>
<td valign="bottom">103.00</td>
<td valign="bottom">-</td>
</tr>
<tr>
<td valign="bottom">104.00</td>
<td valign="bottom">(100.00)</td>
</tr>
<tr>
<td valign="bottom">105.00</td>
<td valign="bottom">(200.00)</td>
</tr>
<tr>
<td valign="bottom">106.00</td>
<td valign="bottom">(300.00)</td>
</tr>
<tr>
<td valign="bottom">107.00</td>
<td valign="bottom">(400.00)</td>
</tr>
<tr>
<td valign="bottom">108.00</td>
<td valign="bottom">(500.00)</td>
</tr>
<tr>
<td valign="bottom">109.00</td>
<td valign="bottom">(600.00)</td>
</tr>
<tr>
<td valign="bottom">110.00</td>
<td valign="bottom">(700.00)</td>
</tr>
</tbody>
</table>
<p style="text-align: center;"><img class="aligncenter size-full wp-image-1284" title="COVERED_PUT" alt="" src="https://financetrain.com/wp-content/uploads/2010/11/COVERED_PUT.gif" width="534" height="367" /></p>

<h3>Option Strategies Spreadsheet</h3>
[download id="18" format="4" autop="false"]

Option Strategies: Covered Put

In the tutorial on risk management applications of options, we will look at how various <a href="https://financetrain.com/types-of-option-strategies/">options strategies</a> can be used for managing risk in a company. Before we start let’s review the key notations used in options formulas:

Time 0 refers to the time when an options strategy is initiated

Time T refers to the time the option will expire

T – 0 is the time to expiry

t is the current time

S refers to the spot price. So, S0 is the price at time 0. ST is the price at time T.

X is the exercise or strike price

c is the call price. Small c is for European calls and capital C is for American calls.

p is the put price. Small p is for European puts and capital P is for American puts.

r is the risk-free rate

p is the profit

When we measure profit in an option transaction, we will consider only the final value minus the initial pay out (premium). We will not take into consideration the risk involved or the time value of money.

Important Notations in Options Formulas

Options Strategies

This frontmatter description will appear below the title

COURSE

Options Strategies

LESSONS