Types of Option Strategies
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.
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:
Covered strategies involve taking a position in the option and the underlying.
Covered Call: This strategy involved being long the underlying stock and short a call option on the same stock.
Covered Put: This involves selling a put option and being short an equivalent amount of the underlying stock.
Protective Put: A protective put involves buying an underlying stock and at the same time buying a put option on the same stock.
Spread strategies involve taking a position in two or more options of the same type (A spread)
Bull Spread: 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.
Bear Spread: 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.
Box Spread: 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.
Butterfly Spread: A butterfly spread is created by using 4 option positions. A long butterfly spread is implemented as follows:
- Long 1 call a high strike price
- Short 2 calls at an intermediate strike price
- Long 1 call at a low strike price
The strikes are equidistant.
- Calendar Spread: 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.
Take a position in a mixture of calls & puts (A combination)
Straddle: 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.
Strip and Strap: A strip involves combining one long call with two long puts. A strap involves combining two long calls with one long put.
Strangle: 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.