## Table of contents

- Overview
- Long Options
- Short Options (Naked)
- Covered Options
- Protective Call, Synthetic Long Put and Married Call
- Protective Put, Synthetic Long Call and Married Put
- Credit and Debit Spreads
- Bear Spreads
- Bull Spreads
- Butterfly Spread
- Calendar Spread
- Option Straddles
- Option Strangles
- Ratio Spreads
- Iron Condor
- Synthetic Options
- Summary

## Overview

We have discovered what options are and how to price them. With this extra knowledge it is time to present some trading strategies for options.

There are numerous trading strategies for options. We have included many different strategies ranging from beginner to advanced.

## Long Options

A long option strategy is likely to be the first that most options traders start with. It involves the purchase of a call or put option with the hope that the underlying asset behaves accordingly. The trader can then sell or exercise the option to realise their profit.

### Long Call Option

A trader will initiate a long call option strategy when they expect the price of the underlying asset to increase above the strike price. The strategy involves the purchase of 1 or more *at the money* call options.

Outlook | Profit Potential | Risk Potential |

Bullish | Unlimited | Limited |

The following graph highlights the expected profit and loss for a long call option strategy. The trader in this example has purchased 1 at the money call option with a strike price of 48.

The breakeven point for this strategy is calculated as the strike price of the long call option plus the premium paid for the long call option.

The maximum profit is theoretically unlimited.

The maximum loss is limited to the premium paid for the long call option.

### Long Put Option

A trader will initiate a long put option strategy when they expect the price of the underlying asset to decrease below the strike price. The strategy involves the purchase of 1 or more *at the money* put options.

Outlook | Profit Potential | Risk Potential |

Bearish | Unlimited | Limited |

The following graph highlights the expected profit and loss for a long put option strategy. The trader in this example has purchased 1 at the money put option with a strike price of 62.

The breakeven point for this strategy is calculated as the strike price of the long put option minus the premium paid for the long put option.

The maximum profit is theoretically unlimited.

The maximum loss is limited to the premium paid for the long put option.

## Short Options (Naked)

A short option strategy is very similar to a long option strategy. Instead of purchasing put or call options, the trader is writing the options. This section describes naked short options. A trader will be considered naked when they do not also own the underlying asset (long or short).

### Short Call Option (Naked)

A trader will initiate a short call option strategy when they expect the price of the underlying asset to remain below the strike price. The strategy involves the trader writing 1 or more *at the money* call options.

Outlook | Profit Potential | Risk Potential |

Bearish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a short call option (naked) strategy. The trader in this example has written 1 at the money call option with a strike price of 48.

The breakeven point for this strategy is calculated as the strike price of the short call option plus the premium received for the short call option.

The maximum profit is limited to the premium received for the short call option.

The maximum loss is theoretically unlimited.

### Short Put Option (Naked)

A trader will initiate a short put option strategy when they expect the price of the underlying asset to remain above the strike price. The strategy involves the trader writing 1 or more *at the money* put options.

Outlook | Profit Potential | Risk Potential |

Bullish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a short put option (naked) strategy. The trader in this example has written 1 at the money put option with a strike price of 62.

The breakeven point for this strategy is calculated as the strike price of the short put option minus the premium received for the short put option.

The maximum profit is limited to the premium received for the short put option.

The maximum loss is theoretically unlimited.

## Covered Options

A covered option strategy is similar to a short naked option strategy. A trader using a covered options strategy will be writing options whilst also owning the underlying asset (long or short).

### Covered Call Option

A trader will initiate a covered call option strategy when they expect the price of the underlying asset to remain fairly static but above the strike price. The strategy involves the trader writing 1 or more *at the money* call options that offset their underlying holding.

Outlook | Profit Potential | Risk Potential |

Bullish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a covered call option strategy. The trader in this example has written 1 at the money call option with a strike price of 48.

The breakeven point for this strategy is calculated as the purchase price of the underlying asset minus the premium received for the short call option.

The maximum profit is calculated as the premium received for the short call option minus the purchase price of the underlying asset plus the strike price of the short call option.

The maximum loss is theoretically unlimited.

### Covered Put Option

A trader will initiate a covered put option strategy when they expect the price of the underlying asset to remain fairly static but below the strike price. The strategy involves the trader writing 1 or more *at the money* put options that offset their underlying holding.

Outlook | Profit Potential | Risk Potential |

Bearish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a covered put option strategy. The trader in this example has written 1 at the money put option with a strike price of 52.

The breakeven point for this strategy is calculated as the sale price of the underlying asset plus the premium received for the short put option.

The maximum profit is calculated as the premium received for the short put option minus the purchase price of the underlying asset plus the strike price of the short put option.

The maximum loss is theoretically unlimited.

## Protective Call, Synthetic Long Put and Married Call

The protective call options strategy is a hedging strategy used by traders that already hold a short position in an underlying security. The strategy involves the trader purchasing an at the money call option to offset their short position.

The protective call options strategy is also referred to as the married call and synthetic long put options strategies.

Outlook | Profit Potential | Risk Potential |

Bearish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a protective call option strategy. The trader in this example has purchased 1 at the money call option with a strike price of 52.

The breakeven point for this strategy is calculated as the sale price of the underlying asset plus the premium paid for the call option.

The maximum profit is theoretically unlimited.

The maximum loss is calculated as the premium paid for the call option plus the strike price of the call option minus the sale price of the underlying asset.

## Protective Put, Synthetic Long Call and Married Put

The protective put options strategy is a hedging strategy used by traders that already hold a long position in an underlying security. The strategy involves the trader purchasing an at the money put option to offset their long position.

The protective put options strategy is also referred to as the married put and synthetic long call options strategies.

Outlook | Profit Potential | Risk Potential |

Bullish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a protective put option strategy. The trader in this example has purchased 1 at the money put option with a strike price of 62.

The breakeven point for this strategy is calculated as the purchase price of the underlying asset plus the premium paid for the put option.

The maximum profit is theoretically unlimited.

The maximum loss is calculated as the premium paid for the put option minus the strike price of the put option plus the purchase price of the underlying asset.

## Credit and Debit Spreads

Spread option strategies occur when options are both purchased and written simultaneously. When a trader purchases options they will always pay a premium. When a trader writes options they will always receive a premium. As spread option strategies involve both writing and purchasing options the net effect will either be a positive or negative balance.

When the net balance for all premiums is positive the option strategy is referred to as a credit spread.

When the net balance for all premiums is negative the option strategy is referred to as a debit spread.

Credit spread vs debit spread?

The majority of spread option strategies can be constructed such that they are either credit or debit spreads.

When a trader initiates a credit spread strategy the net premium received will usually be the maximum profit potential. The trader receives this premium when they initiate the trade.

When a trader initiates a debit spread strategy the net premium paid will usually be the maximum loss potential. The trader pays this net premium when they initiate the trade.

## Bear Spreads

There are 2 types of bear spread option strategies. These are the bear call spread and the bear put spread. Both of these options strategies are bearish and have a very similar profit and loss profile. A trader using either of these strategies is expecting the price of the underlying asset to decline moderately.

Outlook | Profit Potential | Risk Potential |

Bearish | Limited | Limited |

The following graph highlights the expected profit and loss for a bear spread option strategy.

The following two sections describe the bear put spread and bear call spread in more detail.

### Bear Put Spread

A trader entering a bear put spread will purchase 1 in the money put option and simultaneously write 1 out of the money put option. Both options must have the same expiration date. The bear put spread will generate a net debit for both premiums. For this reason the bear put spread is also referred to as the bear put debit spread.

The breakeven point for this strategy is calculated as the strike price of the long put option minus the net premium paid for both options.

The maximum profit is calculated as the strike price of the long put option minus the strike price of the short put option minus the net premium paid for the options.

The maximum loss is calculated as the net premium paid for both options.

### Bear Call Spread

A trader entering a bear call spread will purchase 1 out of the money call option and simultaneously write 1 in the money call option. Both options must have the same expiration date. The bear call spread will generate a net credit for premiums. For this reason the bear call spread is also referred to as the bear call credit spread.

The breakeven point for this strategy is calculated as the strike price of the the short call option plus the net premium received for both options.

The maximum profit is calculated as the net premium received for both options.

The maximum loss is calculated as the strike price of the long call option minus the strike price of the short call option minus the net premium received for both options.

## Bull Spreads

There are 2 types of bull spread option strategies. These are the bull call spread and the bull put spread. Both of these options strategies are bullish and have a very similar profit and loss profile. A trader using either of these strategies is expecting the price of the underlying asset to increase moderately.

Outlook | Profit Potential | Risk Potential |

Bullish | Limited | Limited |

The following graph highlights the expected profit and loss for a bull spread option strategy.

The following two sections describe the bull put spread and bull call spread in more detail.

### Bull Put Spread

A trader entering a bull put spread will purchase 1 out of the money put option and simultaneously write 1 in the money put option. Both options must have the same expiration date. The bull put spread will generate a net credit for both premiums. For this reason the bull put spread is also referred to as the bull put credit spread.

The breakeven point for this strategy is calculated as the strike price of the short put option minus the net premium received for both options.

The maximum profit is calculated as the the net premium received for both options.

The maximum loss is calculated as strike price of the short put option minus the strike price of the long put option minus the net premium received for both options.

### Bull Call Spread

A trader entering a bull call spread will purchase 1 in the money call option and simultaneously write 1 out of the money call option. Both options must have the same expiration date. The bull call spread will generate a net debit for both premiums. For this reason the bull call spread is also referred to as the bull call debit spread.

The breakeven point for this strategy is calculated as the strike price of the long call option plus the net premium paid for both options.

The maximum profit is calculated as the strike price of the short call option minus the strike price of the long call option minus the net premium paid for both options.

The maximum loss is calculated as the net premium paid for both options.

## Butterfly Spread

The butterfly spread options strategy is a neutral strategy. A trader using this strategy does not believe that the underlying price will deviate far from the current price before the expiration date.

Outlook | Profit Potential | Risk Potential |

Neutral | Limited | Limited |

The following graph highlights the expected profit and loss for a butterfly spread option strategy. The trader in this example has purchased 1 in the money call option with a strike price of 40 and 1 out of the money call option with a strike price of 60. The trader has also written 2 out of the money call options with a strike price of 50. All options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the higher long call minus the net premium paid for both options. The lower breakeven point for this strategy is calculated as the strike price of the lower long call plus the net premium paid for both options.

The maximum profit is calculated as the strike price of the short call option minus the strike price of the lower long call minus the net premium paid for both options.

The maximum loss is calculated as the net premium paid for both options.

## Calendar Spread

The calendar spread options strategy is a neutral strategy. A trader using this strategy does not believe that the underlying price will deviate far from the current price in the short term.

Outlook | Profit Potential | Risk Potential |

Neutral | Limited | Limited |

The following graph highlights the expected profit and loss for a calendar spread option strategy. The trader in this example has written 1 near term at the money call option with a strike price of 50. The trader also purchased 1 long term at the money call option with a strike price of 50.

Calculating the breakeven point for this strategy is complex as the strategy involves differing expiration dates. The breakeven point is not fixed due to this and will also change once the near call option expires.

The maximum profit is calculated as the premium received for the sale of the near call option minus the time decay incurred on the long call option. This changes once the near term option has expired as the strategy turns into a simple long call option.

The maximum loss is calculated as the net premium paid for both options. This also changes once the near term option has expired and is simply the price paid for the long call option.

## Option Straddles

The option straddle strategy is a neutral strategy. This strategy allows a trader to profit from an increase or decrease in the volatility of an underlying asset.

### Long Option Straddle

A trader using this strategy believes that the underlying asset will experience increased levels of volatility but does not know in which direction price will move.

Outlook | Profit Potential | Risk Potential |

Neutral (high volatility) | Unlimited | Limited |

The following graph highlights the expected profit and loss for a long option straddle strategy. The trader in this example has purchased 1 at the money call option with a strike price of 50 and purchased 1 at the money put option with a strike price of 50. Both options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the long call option plus the net premium paid for both options. The lower breakeven point is calculated as the strike price of the long put option minus the net premium paid for both options.

The maximum profit is theoretically unlimited.

The maximum loss is calculated as the net premium paid for both options.

### Short Option Straddle

A trader using this strategy believes that the underlying asset will experience reduced levels of volatility but does not know in which direction price will move.

Outlook | Profit Potential | Risk Potential |

Neutral (low volatility) | Limited | Unlimited |

The following graph highlights the expected profit and loss for a short option straddle strategy. The trader in this example has written 1 at the money call option with a strike price of 50 and written 1 at the money put option with a strike price of 50. Both options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the short call option plus the net premium received for both options. The lower breakeven point is calculated as the strike price of the short put option minus the net premium received for both options.

The maximum profit is calculated as the net premium received for both options.

The maximum loss is theoretically unlimited.

## Option Strangles

The option strangle strategy is neutral and very similar to the option straddle strategy. This strategy allows a trader to profit from an increase or decrease in the volatility of an underlying asset. The option strangle differs to the straddle because it uses multiple strike prices.

### Long Option Strangle

A trader using this strategy believes that the underlying asset will experience increased levels of volatility but does not know in which direction price will move.

Outlook | Profit Potential | Risk Potential |

Neutral (high volatility) | Unlimited | Limited |

The following graph highlights the expected profit and loss for a long option strangle strategy. The trader in this example has purchased 1 out of the money call option with a strike price of 55 and purchased 1 out of the money put option with a strike price of 45. Both options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the long call option plus the net premium paid for both options. The lower breakeven point is calculated as the strike price of the long put option minus the net premium paid for both options.

The maximum profit is theoretically unlimited.

The maximum loss is calculated as the net premium paid for both options.

### Short Option Strangle

A trader using this strategy believes that the underlying asset will experience reduced levels of volatility but does not know in which direction price will move.

Outlook | Profit Potential | Risk Potential |

Neutral (low volatility) | Limited | Unlimited |

The following graph highlights the expected profit and loss for a long option strangle strategy. The trader in this example has written 1 out of the money call option with a strike price of 55 and written 1 out of the money put option with a strike price of 45. Both options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the short call option plus the net premium received for both options. The lower breakeven point is calculated as the strike price of the short put option minus the net premium received for both options.

The maximum profit is calculated as the net premium received for both options.

The maximum loss is theoretically unlimited.

## Ratio Spreads

Ratio spread option strategies are neutral. This strategy allows a trader to profit from a decrease in the volatility of an underlying asset. The ratio spread also eliminates either upside or downside risk.

### Put Ratio Spread Option

A trader using this strategy believes that the underlying asset will experience reduced levels of volatility. All risk is eliminated on the upside.

Outlook | Profit Potential | Risk Potential |

Neutral, Moderately Bullish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a put ratio spread option strategy. The trader in this example has purchased 1 in the money put option with a strike price of 80 and written 2 out of the money put options with a strike price of 60. Both options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the long put option plus/minus the net premium paid/received for all options. The lower breakeven point is calculated as the strike price of the short put options minus the difference between the 2 strike values.

The maximum profit is calculated as the strike price of the long put option minus the strike price of the short put option plus the net premium received.

The maximum loss is theoretically unlimited but only occurs when the underlying price falls.

### Call Ratio Spread Option

A trader using this strategy believes that the underlying asset will experience reduced levels of volatility. All risk is eliminated on the downside.

Outlook | Profit Potential | Risk Potential |

Neutral, Moderately Bearish | Limited | Unlimited |

The following graph highlights the expected profit and loss for a put ratio spread option strategy. The trader in this example has purchased 1 in the money call option with a strike price of 30 and written 2 out of the money call options with a strike price of 50. Both options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the short call options plus the difference between the 2 strike values. The lower breakeven point is calculated as the strike price of the long call option plus/minus the net premium paid/received for all options.

The maximum profit is calculated as the strike price of the short call option minus the strike price of the long call option plus the net premium received.

The maximum loss is theoretically unlimited but only occurs when the underlying price increases.

## Iron Condor

The iron condor options strategy is a neutral strategy with limited risk. The underlying asset can trade in either direction and still generate a profit. The strategy is designed to have a high probability of generating a small profit and is especially effective in assets that have low volatility.

The iron condor strategy is the combination of the bull put spread and a bear call spread option strategies.

Outlook | Profit Potential | Risk Potential |

Neutral | Limited | Unlimited |

The following graph highlights the expected profit and loss for a iron condor option strategy. The trader in this example has purchased 1 out of the money put option with a strike price of 45 and written 1 out of the money put option with a strike price of 50. The trader also wrote 1 out of the money call option with a strike price of 60 and purchased 1 out of the money call option with a strike price of 55. All 4 options must have the same expiration date.

The upper breakeven point for this strategy is calculated as the strike price of the short call option plus the net premium received for all options. The lower breakeven point is calculated as the strike price of the short put option minus the net premium received for all options.

The maximum profit is the net premium received for all options.

The maximum loss is calculated as the strike price of the long call option minus the strike price of the short call option minus the net premium received.

## Synthetic Options

Synthetic options are an affordable way of replicating the performance of a standard portfolio without the need to purchase large quantities of stocks and shares.

The following 2 sections describe how to replicate a long or short position in stocks by using a synthetic option strategy.

### Synthetic Long Stock

A trader will use the synthetic long stock options strategy when they want to replicate the performance of holding a long position in a real asset. The trader would not need the same level of capital to fund a synthetic long stock options strategy as compared to owning an outright long position.

This strategy involves purchasing *at the money* call options and simultaneously selling the same number of *at the money* put options. The call and put options must have the same strike price and expiration date.

Outlook | Profit Potential | Risk Potential |

Bullish | Unlimited | Unlimited |

The breakeven point for this strategy is calculated as the strike price of the long call option plus the net premium paid for both options.

### Synthetic Short Stock

A trader will use the synthetic short stock options strategy when they want to replicate the performance of holding a short position in a real asset. The trader would not need the same level of capital to fund a synthetic short stock options strategy as compared to owning an outright short position.

This strategy involves purchasing *at the money* put options and simultaneously selling the same number of *at the money* call options. The call and put options must have the same strike price and expiration date.

Outlook | Profit Potential | Risk Potential |

Bearish | Unlimited | Unlimited |

The breakeven point for this strategy is calculated as the strike price of the long put option plus the net premium received for both options.

## Summary

This page has uncovered the vast opportunities that options trading brings. From simple long options to the complex iron condor, there is a strategy for any trading scenario.

If there are any other strategies you would like Trading AtoZ to cover then please be in touch and we will add them to this page.

If you want to learn more about options trading then I would recommend a book Options as a Strategic Investment. This is available from our suggested reading section.