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

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

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:

1. 1. Long 1 call a high strike price
   2. Short 2 calls at an intermediate strike price
   3. 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.

Combination Strategies

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.