Bullish Strategies

Call Buying
Bull Call Spread
The Collar
Call Backspread
Bull Calendar Spread
Covered Calls
Naked Puts
Covered Straddle

Bearish Strategies

Put Buying
Bear Put Spread
Put Backspread
Covered Puts
Naked Calls

Neutral Strategies

Ratio Spread
The Straddle
The Strangle
The Butterfly
The Condor
The Iron Butterfly
The Iron Condor
Calendar Straddle

Other Strategies

Calendar Spread
Synthetic Positions
Options Arbitrage

Options Brokerages

optionsXpress
thinkOrSwim

Bullish Strategies

Call Buying

The long call is the simplest strategy in options trading and involves the purchase
of a call option. The options trader employing the long call strategy believes that
the price of the underlying stock will go up beyond a certain price within a certain
period of time.
Bull Call Spread

A bull call spread is a bullish strategy in options trading that is established by

buying an at-the-money call while simultaneously writing a higher striking out-of-
the-money call of the same underlying security and the same expiration month.

Example
An options trader believes that XYZ stock trading at $42 is going to rally soon and
enters a bull call spread by buying a JUL 40 call for $300 and writing a JUL 45 call
for $100. The net investment required to put on the spread is a debit of $200.

The stock price of XYZ begins to rise and closes at $46 on expiration date. Both
options expire in-the-money with the JUL 40 call having an intrinsic value of $600
and the JUL 45 call having an intrinsic value of $100. This means that the spread
is now worth $500 at expiration. Since the trader had a debit of $200 when he
bought the spread, his net profit is $300.

If the price of XYZ had declined to $38 instead, both options expire worthless.
The trader will lose his entire investment of $200, which is also his maximum
possible loss.

The Collar

A collar is an options trading strategy that is constructed by holding shares of the

underlying stock while simultaneously buying protective puts and selling call
options against that holding. The puts and the calls are both out-of-the-money
options having the same expiration month and must be equal in number of
contracts.

Example
Suppose an options trader is holding 100 shares of the stock XYZ currently
trading at $48 in June. He decides to establish a collar by writing a JUL 50
covered call for $2 while simultaneously purchases a JUL 45 put for $1.

Since he pays $4800 for the 100 shares of XYZ, another $100 for the put but
receives $200 for selling the call option, his total investment is $4700.

On expiration date, the stock had rallied by 5 points to $53. Since the striking
price of $50 for the call option is lower than the trading price of the stock, the call
is assigned and the trader sells the shares for $5000, resulting in a $300 profit
($5000 minus $4700 original investment).

However, what happens should the stock price had gone down 5 points to $43
instead? Let's take a look.

At $43, the call writer would have had incurred a paper loss of $500 for holding
the 100 shares of XYZ but because of the JUL 45 protective put, he is able to sell
his shares for $4500 instead of $4300. Thus, his net loss is limited to only $200
($4500 minus $4700 original investment).

Had the stock price remain stable at $48 at expiration, he will still net a paper
gain of $100 since he only paid a total of $4700 to acquire $4800 worth of stock.
Call Backspread

The call backspread (reverse call ratio spread) is a bullish strategy in options
trading that involves selling a number of call options and buying more call options
of the same underlying stock and expiration date at a higher strike price. It is an
unlimited profit, limited risk options trading strategy that is taken when the
options trader thinks that the underlying stock will experience significant upside
movement in the near term.

A 2:1 call backspread can be implemented by selling a number of calls at a lower

strike and buying twice the number of calls at a higher strike.

Example

Suppose XYZ stock is trading at $43 in June. An options trader executes a 2:1
call backspread by selling a JUL 40 call for $400 and buying two JUL 45 calls for
$200 each. The net debit/credit taken to enter the trade is zero.

On expiration in July, if XYZ stock is trading at $45, both the JUL 45 calls expire
worthless while the short JUL 40 call expires in the money with $500 in intrinsic
value. Buying back this call to close the position will result in the maximum loss
of $500 for the options trader.

If XYZ stock rallies and is trading at $50 on expiration in July, all the options will
expire in the money. The short JUL 40 call is worth $1000 and needs to be
bought back to close the position. Since the two JUL 45 call bought is now worth
$500 each, their combined value of $1000 is just enough to offset the losses from
the written call. Therefore, he achieves breakeven at $50.

Beyond $50 though, there will be no limit to the gains possible. For example, at
$60, each long JUL 45 call will be worth $1500 while his single short JUL 40 call is
only worth $2000, resulting in a profit of $1000.

If the stock price had dropped to $40 or below at expiration, all the options
involved will expire worthless. Since the net debit to put on this trade is zero,
there is no resulting loss.
Bull Calendar Spread

Using calls, the bull calendar spread strategy can be setup by buying long term
slightly out-of-the-money calls and simultaneously writing an equal number of
near month calls of the same underlying security with the same strike price.

The options trader applying this strategy is bullish for the long term and is selling
the near month calls with the the intention to ride the long term calls for free.

Example

In June, an options trader believes that XYZ stock trading at $40 is going to rise
gradually over the next four months. He enters a bull calendar spread by buying
an OCT 45 out-of-the-money call for $200 and writing a JUL 45 out-of-the-money
call for $100. The net investment required to put on the spread is a debit of
$100.

In July, The stock price of XYZ goes up to $42 and the JUL 45 call expires
worthless. Subsequently, the price of XYZ stock rises to $49 in October. The OCT
45 call expires in the money and is worth $400 on expiration. Since the initial
debit taken to enter the trade is $100, his profit comes to $300.

Suppose the price of XYZ did not rise much and remains at or below $45 all the
way until expiration of the long term call in October, the trader will lose the initial
debit of $100 as both calls expire worthless.
Covered Calls

The covered call is a strategy in options trading whereby a call option is sold
against a holding of the underlying stock.

The writer of a covered call is typically slightly bullish or neutral toward the
underlying security. The covered call writer's profit potential is limited as he had,
in return for the premium, given up the chance to fully profit from a substantial
rise in the price of the underlying asset.

Naked Puts or Uncovered Put Writing

Writing uncovered puts is an options trading strategy involving the selling of put
options without shorting the obligated shares of the underlying stock. Also known
as naked put writing, this is a bullish options strategy that is executed to earn a
consistent profits by ongoing collection of premiums.

Example

Suppose XYZ stock is trading at $45 in June. An options trader writes an

uncovered JUL 45 put for $200.

If XYZ stock rallies to $50 on expiration, the JUL 45 put expires worthless and the
trader gets to keep the $200 in premim as profit. This is also his maximum profit
and is achieved as long as XYZ stock trades above $45 on options expiration
date.

If instead XYZ stock drops to $40 on expiration, then the JUL 45 put expires in
the money with $500 in intrinsic value. The JUL 45 put needs to be bought back
for $500 and subtracting the initial credit of $200 taken, the resulting net loss is
$300

Covered Straddle

The covered straddle is a bullish strategy in options trading that involves the
simultaneous selling of equal number of puts and calls of the same underlying
stock, striking price and expiration date while owning the underlying stock. Note
that only the call options are covered.

Covered straddles are limited profit, unlimited risk options strategies similar to
the writing of covered calls. Another way to describe a covered straddle is that it
is simply a combination of a covered call write and a naked put write. Since the
naked put write has a risk/reward profile of a covered call, a covered straddle can
also be thought of as the equivalent of two covered calls.
Example
Suppose XYZ stock is trading at $54 in June. An options trader enters a covered
straddle by selling a JUL 55 put for $300 and a JUL 55 call for $400 while
purchasing 100 shares of XYZ for $5400. The total premiums received for selling
the options is $700.

On expiration in July, if XYZ stock rallies above the strike price to $57, the JUL 55
put expires worthless while the JUL 55 call expires in the money and the 100
shares get called away for $5500, producing a gain of $100. Including the $700
in premiums received upon entering the trade, the total profit comes to $800
which is also the maximum profit attainable.

However, if the stock price drops below the breakeven to $45, the JUL 55 call
expires worthless but the naked JUL 55 put and long stock position suffer large
losses. The short JUL 55 put is now worth $1000 and needs to be bought back
while the long stock position has lost $900 in value. Factoring in the $700
premiums received earlier, the total loss comes to $1200.

Bearish Strategies

Put Buying

The long put is a simple strategy in options trading that involves the purchase of
a put option. The options trader employing the long put strategy believes that the
price of the underlying stock will go down beyond a certain price before the
expiration date.

Bear Put Spread

This strategy requires the options trader to buy a higher striking in-the-money
put option and sell a lower striking out-of-the-money put option on the same
stock with the same expiration date. Also known as a vertical bear put spread.

Put Backspread

The put backspread (reverse put ratio spread) is a bearish strategy in options
trading that involves selling a number of put options and buying more put options
of the same underlying stock and expiration date at a lower strike price. It is an
unlimited profit, limited risk options trading strategy that is taken when the
options trader thinks that the underlying stock will experience significant
downside movement in the near term.

A 2:1 put backspread can be implemented by buying a number of puts at a

higher strike and buying twice the number of calls at a lower strike.

Example

Suppose XYZ stock is trading at $48 in June. An options trader executes a 2:1 put
backspread by selling a JUL 50 put for $400 and buying two JUL 45 puts for $200
each. The net debit/credit taken to enter the trade is zero.

On expiration in July, if XYZ stock is trading at $45, both the JUL 45 puts expire
worthless while the short JUL 50 put expires in the money with $500 in intrinsic
value. Buying back this put to close the position will result in the maximum loss
of $500 for the options trader.

If XYZ stock drops to $40 on expiration in July, all the options will expire in the
money. The short JUL 50 put is worth $1000 and needs to be bought back to
close the position. Since the two JUL 45 puts bought is now worth $500 each,
their combined value of $1000 is just enough to offset the losses from the written
put. Therefore, he achieves breakeven at $40.

Below $40 though, there will be no limit to the gains possible. For example, at
$30, each long JUL 45 put will be worth $1500 while his single short JUL 50 put is
only worth $2000, resulting in a profit of $1000.

If the stock price had rallied to $50 or higher at expiration, all the options
involved will expire worthless. Since the net debit to put on this trade is zero,
there is no resulting loss.

Covered Puts or Covered Put Writing

Writing covered puts is a bearish options trading strategy involving the writing of
put options while shorting the obligated shares of the underlying stock.

Example

Suppose XYZ stock is trading at $45 in June. An options trader writes a covered
put by selling a JUL 45 put for $200 while shorting 100 shares of XYZ stock. The
net credit taken to enter the position is $200, which is also his maximum possible
profit.

On expiration in July, XYZ stock is still trading at $45. The JUL 45 put expires
worthless while the trader covers his short position with no loss. In the end, he
gets to keep the entire credit taken as profit.

If instead XYZ stock drops to $40 on expiration, the short put will expire in the
money and is worth $500 but this loss is offset by the $500 gain in the short
stock position. Thus, the profit is still the initial credit of $200 taken on entering
the trade.

However, should the stock rally to $55 on expiration, a significant loss results. At
this price, the short stock position taken when XYZ stock was trading at $45
suffers a $1000 loss. Subtracting the initial credit of $200 taken, the resulting
loss is $800.
Naked Calls or Naked Call Writing

The naked call write is a risky options trading strategy where the options trader
sells calls against stock which he does not own. Also known as uncovered call
writing.

The options trader must be careful in the selection of the strike price of the call to
be written as it has a significant impact to the profit/loss potential of the trade.

If one is neutral to mildly bearish on the underlying, one would execute a

premium collection strategy by writing out-of-the-money naked calls.

If one is bearish to very bearish, then one would write deep-in-the-money naked
calls as an alternative to shorting the underlying stock.

Neutral Strategies

Ratio Spread

The ratio spread is a neutral strategy in options trading that involves buying a
number of options and selling more options of the same underlying stock and
expiration date at a different strike price. It is a limited profit, unlimited risk
options trading strategy that is taken when the options trader thinks that the
underlying stock will experience little volatility in the near term.

Call Ratio Spread

Using calls, a 2:1 call ratio spread can be implemented by buying a number of
calls at a lower strike and selling twice the number of calls at a higher strike.

Example

Suppose XYZ stock is trading at $43 in June. An options trader executes a 2:1
ratio call spread by buying a JUL 40 call for $400 and selling two JUL 45 calls for
$200 each. The net debit/credit taken to enter the trade is zero.

On expiration in July, if XYZ stock is trading at $45, both the JUL 45 calls expire
worthless while the long JUL 40 call expires in the money with $500 in intrinsic
value. Selling or exercising this long call will give the options trader his maximum
profit of $500.

If XYZ stock rallies and is trading at $50 on expiration in July, all the options will
expire in the money but because the trader has written more calls than he has
bought, he will need to buy back the written calls which have increased in value.
Each JUL 45 call written is now worth $500. However, his long JUL 40 call is
worth $1000 and is just enough to offset the losses from the written calls.
Therefore, he achieves breakeven at $50.

Beyond $50 though, there will be no limit to the loss possible. For example, at
$60, each written JUL 45 call will be worth $1500 while his single long JUL 40 call
is only worth $2000, resulting in a loss of $1000.

However, there is no downside risk to this trade. If the stock price had dropped to
$40 or below at expiration, all the options involved will expire worthless. Since
the net debit to put on this trade is zero, there is no resulting loss.
Put Ratio Spread

The put ratio spread is a neutral strategy in options trading that involves buying a
number of put options and selling more put options of the same underlying stock
and expiration date at a different strike price. It is a limited profit, unlimited risk
options trading strategy that is taken when the options trader thinks that the
underlying stock will experience little volatility in the near term.

A 2:1 put ratio spread can be implemented by buying a number of puts at a

higher strike and selling twice the number of puts at a lower strike.

Example
Suppose XYZ stock is trading at $48 in June. An options trader executes a 2:1
ratio put spread by buying a JUL 50 put for $400 and selling two JUL 45 puts for
$200 each. The net debit/credit taken to enter the trade is zero.

On expiration in July, if XYZ stock is trading at $45, both the JUL 45 puts expire
worthless while the long JUL 50 put expires in the money with $500 in intrinsic
value. Selling or exercising this long put will give the options trader his maximum
profit of $500.

If XYZ stock price drops and is trading at $40 on expiration in July, all the options
will expire in the money but because the trader has written more puts than he
has purchased, he will need to buy back the written puts which have increased in
value. Each JUL 45 put written is now worth $500. However, his long JUL 50 put
is worth $1000 and is just enough to offset the losses from the written puts.
Therefore, he achieves breakeven at $40.

Below $40, there will be no limit to the maximum possible loss. For example, at
$30, each of the two written JUL 45 puts will be worth $1500 while his single long
JUL 50 put is only worth $2000, resulting in a loss of $1000.

However, there is no upside risk to this trade. If the stock price had rallied to $50
or higher at expiration, all the options involved will expire worthless. Since the
net debit to put on this trade is zero, there is no resulting loss.

The Straddle

Long Straddle (or Buy Straddle)

The long straddle, also known as buy straddle or simply "straddle", is a neutral
strategy in options trading that involve the simultaneously buying of a put and a
call of the same underlying stock, striking price and expiration date. Long
straddles are unlimited profit, limited risk options trading strategies that are used
when the options trader thinks that the underlying securities will
experience significant volatility in the near term.
Example

Suppose XYZ stock is trading at $40 in June. An options trader enters a long
straddle by buying a JUL 40 put for $200 and a JUL 40 call for $200. The net
debit taken to enter the trade is $400, which is also his maximum possible loss.

If XYZ stock is trading at $50 on expiration in July, the JUL 40 put will expire
worthless but the JUL 40 call expires in the money and has an intrinsic value of
$1000. Subtracting the initial debit of $400, the long straddle trader's profit
comes to $600.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and
the JUL 40 call expire worthless and the long straddle trader suffers a maximum
loss which is equal to the initial debit of $400 taken to enter the trade.

Short Straddle (or Sell Straddle)

The short straddle - a.k.a. sell straddle or naked straddle sale - is a neutral
options strategy that involve the simultaneous selling of a put and a call of the
same underlying stock, striking price and expiration date. Short straddles are
limited profit, unlimited risk options trading strategies that are used when the
options trader thinks that the underlying securities will experience little
volatility in the near term.

Example

Suppose XYZ stock is trading at $40 in June. An options trader enters a short
straddle by selling a JUL 40 put for $200 and a JUL 40 call for $200. The net
credit taken to enter the trade is $400, which is also his maximum possible profit.

If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 40 put will
expire worthless but the JUL 40 call expires in the money and has an intrinsic
value of $1000. Subtracting the initial credit of $400, the short straddle trader's
loss comes to $600.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and
the JUL 40 call expire worthless and the short straddle trader gets to keep the
entire initial credit of $400 taken to enter the trade as profit.

The Strangle

Long Strangle (or Buy Strangle)

The long strangle, also known as buy strangle or simply "strangle", is a neutral
strategy in options trading that involve the simultaneous buying of a slightly
out-of-the-money put and a slightly out-of-the-money call of the same
underlying stock and expiration date. It is an unlimited profit, limited risk
strategy that is taken when the options trader thinks that the underlying stock
will experience significant volatility in the near term. The long strangle is a debit
spread as a net debit is taken to enter the trade.

Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a long
strangle by buying a JUL 35 put for $100 and a JUL 45 call for $100. The net
debit taken to enter the trade is $200, which is also his maximum possible loss.
If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 35 put will
expire worthless but the JUL 45 call expires in the money and has an intrinsic
value of $500. Subtracting the initial debit of $200, the options trader's profit
comes to $300.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 35 put and
the JUL 45 call expire worthless and the options trader suffers a maximum loss
which is equal to the initial debit of $200 taken to enter the trade.

Short Strangle (or Sell Strangle)

The short strangle, also known as sell strangle, is a neutral strategy in options
trading that involve the simultaneous selling of a slightly out-of-the-money put
and a slightly out-of-the-money call of the same underlying stock and expiration
date. It is a limited profit, unlimited risk options trading strategy that is taken
when the options trader thinks that the underlying stock will experience little
volatility in the near term. The short strangle is a credit spread as a net credit is
taken to enter the trade.

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes a short
strangle by selling a JUL 35 put for $100 and a JUL 45 call for $100. The net
credit taken to enter the trade is $200, which is also his maximum possible profit.

If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 35 put will
expire worthless but the JUL 45 call expires in the money and has an intrinsic
value of $500. Subtracting the initial credit of $200, the options trader's loss
comes to $300.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 35 put and
the JUL 45 call expire worthless and the options trader gets to keep the entire
initial credit of $200 taken to enter the trade as profit.

The Butterfly

Butterfly Spread

The butterfly spread is a neutral strategy that is a combination of a bull spread

and a bear spread. It is a limited profit, limited risk options strategy. There are 3
striking prices involved in a butterfly spread and it can be constructed using calls
or puts.

Long Call Butterfly

Long butterflies are entered when the investor thinks that the underlying stock
will not rise or fall much by expiration. Using calls, the long butterfly can be
constructed by buying one lower striking in-the-money call, writing two at-the-
money calls and buying another higher striking out-of-the-money call. A resulting
net debit is taken to enter the trade.

Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a long
call butterfly by purchasing a JUL 30 call for $1100, writing two JUL 40 calls for
$400 each and purchasing another JUL 50 call for $100. The net debit taken to
enter the position is $400, which is also his maximum possible loss.

On expiration in July, XYZ stock is still trading at $40. The JUL 40 calls and the
JUL 50 call expire worthless while the JUL 30 call still has an intrinsic value of
$1000. Subtracting the initial debit of $400, the resulting profit is $600, which is
also the maximum profit attainable.

Maximum loss results when the stock is trading below $30 or above $50. At $30,
all the options expires worthless. Above $50, any "profit" from the two long calls
will be neutralised by the "loss" from the two short calls. In both situations, the
butterfly trader suffers maximum loss which is the initial debit taken to enter the
trade.

Long Put Butterfly

The long put butterfly spread is a neutral strategy that is a combination of a bull
put spread and a bear put spread. It is a limited profit, limited risk options
trading strategy that is taken when the options trader thinks that the underlying
stock will not rise or fall much by expiration. There are 3 striking prices involved
in a long put butterfly spread and it is constructed by buying one lower striking
put, writing two at-the-money puts and buying another higher striking put for a
net debit.

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes a long
put butterfly by buying a JUL 30 put for $100, writing two JUL 40 puts for $400
each and buying another JUL 50 put for $1100. The net debit taken to enter the
trade is $400, which is also his maximum possible loss.

On expiration in July, XYZ stock is still trading at $40. The JUL 40 puts and the
JUL 30 put expire worthless while the JUL 50 put still has an intrinsic value of
$1000. Subtracting the initial debit of $400, the resulting profit is $600, which is
also the maximum profit attainable.

Maximum loss results when the stock is trading below $30 or above $50. At $50,
all the options expires worthless. Below $30, any "profit" from the two long puts
will be neutralised by the "loss" from the two short puts. In both situations, the
long put butterfly trader suffers maximum loss which is equal to the initial debit
taken to enter the trade.

Short Butterfly

The short butterfly is a neutral strategy like the long butterfly but bullish on
volatility. It is a limited profit, limited risk options trading strategy. There are 3
striking prices involved in a short butterfly spread and it can be constructed using
calls or puts.
Short Call Butterfly
Using calls, the short butterfly can be constructed by writing one lower striking
call, buying two at-the-money calls and writing another higher striking call, giving
the trader a net credit to enter the position.

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes a short
call butterfly by writing a JUL 30 call for $1100, buying two JUL 40 calls for $400
each and writing another JUL 50 call for $100. The net credit taken to enter the
position is $400, which is also his maximum possible profit.

On expiration in July, XYZ stock has dropped to $30. All the options expire
worthless and the short butterfly trader gets to keep the entire initial credit taken
of $400 as profit. This is also the maximum profit attainable and is also obtained
even if the stock had instead rallied to $50 or beyond.

On the downside, should the stock price remains at $40 at expiration, maximum
loss will be incurred. At this price, all except the lower striking call expires
worthless. The lower striking call sold short would have a value of $1000 and
needs to be bought back. Subtracting the initial credit of $400 taken, the net loss
(maximum) is equal to $600.

Short Put Butterfly

The short put butterfly is a neutral strategy like the long put butterfly but bullish
on volatility. It is a limited profit, limited risk options strategy. There are 3
striking prices involved in a short put butterfly and it can be constructed by
writing one lower striking out-of-the-money put, buying two at-the-money puts
and writing another higher striking in-the-money put, giving the options trader a
net credit to put on the trade.

Example
Suppose XYZ stock is trading at $40 in June. An options trader executes a short
put butterfly by writing a JUL 30 put for $100, buying two JUL 40 puts for $400
each and writing another JUL 50 put for $1100. The net credit taken to enter the
position is $400, which is also his maximum possible profit.

On expiration in July, XYZ stock has dropped to $30. All the options expire
worthless and the short put butterfly trader gets to keep the entire initial credit
taken of $400 as profit. This is also the maximum profit attainable and is also
obtained even if the stock had instead rallied to $50 or beyond.

On the downside, should the stock price remains at $40 at expiration, maximum
loss will be incurred. At this price, all except the higher striking put expires
worthless. The higher striking put sold short would have a value of $1000 and
needs to be bought back to close the trade. Subtracting the initial credit of $400
taken, the net loss (maximum) is equal to $600.
The Condor

The condor is a neutral strategy similar to the butterfly in that it is also a limited
risk, limited profit trading strategy that is structured to earn a profit when the
underlying stock is perceived to have little volatility.

Using calls, the options trader can setup a long condor by combining a bull call
spread and a bear call spread. The trader enters a long call condor by writing a
lower strike in-the-money call, buying an even lower striking in-the-money call,
writing a higher strike out-of-the-money call and buying another even higher
striking out-of-the-money call. A total of 4 legs are involved in this trading
strategy and it requires a net debit to enter the trade.

Example

Suppose XYZ stock is trading at $45 in June. An options trader executes a condor
by buying a JUL 35 call for $1100, writing a JUL 40 call for $700, writing another
JUL 50 call for $200 and buying another JUL 55 call for $100. The net debit
required to enter the trade is $300, which is also his maximum possible loss.

To further see why $300 is the maximum possible loss, lets examine what
happens when the stock price falls to $35 or rise to $55 on expiration.

At $35, all the options expire worthless, so the initial debit taken of $300 is his
maximum loss.

At $55, the long JUL 55 call expires worthless while the long JUL 35 call worth
$2000 is used to offset the loss from the short JUL 40 call (worth $1500) and the
short JUL 50 call (worth $500). Thus, the long condor trader still suffers the
maximum loss that is equal to the $300 initial debit taken when entering the
trade.

If instead on expiration in July, XYZ stock is still trading at $45, only the JUL 35
call and the JUL 40 call expires in the money. With his long JUL 35 call worth
$1000 to offset the short JUL 40 call valued at $500 and the initial debit of $300,
his net profit comes to $200.

The condor's maximum profit may be low in relation to other trading strategies
but it has a comparatively wider profit zone. In this example, maximum profit is
achieved if the underlying stock price at expiration is anywhere between $40 and
$50.

Short Condor

The short condor is a neutral strategy similar to the short butterfly. It is a limited
risk, limited profit trading strategy that is structured to earn a profit when the
underlying stock is perceived to be making a sharp move in either direction.

Using calls, the options trader can setup a short condor by combining a bear call
spread and a bull call spread. The trader enters a short call condor by buying a
lower strike in-the-money call, selling an even lower striking in-the-money call,
buying a higher strike out-of-the-money call and selling another even higher
striking out-of-the-money call. A total of 4 legs are involved in this trading
strategy and a net credit is received on entering the trade.
Example
Suppose XYZ stock is trading at $45 in June. An options trader executes a short
condor by selling a JUL 35 call for $1100, buying a JUL 40 call for $700, buying
another JUL 50 call for $200 and selling another JUL 55 call for $100. A net credit
of $300 is received on entering the trade.

To further see why $300 is the maximum possible profit, lets examine what
happens when the stock price falls to $35 or rise to $55 on expiration.

At $35, all the options expire worthless, so the initial credit taken of $300 is his
maximum profit.

At $55, the short JUL 55 call expires worthless while the profit from the long JUL
40 call (worth $1500) and the long JUL 50 call (worth $500) is used to offset the
short JUL 35 call worth $2000 . Thus, the short condor trader still earns the
maximum profit that is equal to the $300 initial credit taken when entering the
trade.

On the flip side, if XYZ stock is still trading at $45 on expiration in July, only the
JUL 35 call and the JUL 40 call expire in the money. With his long JUL 40 call
worth $500 and the initial credit of $300 received to offset the short JUL 35 call
valued at $1000, there is still a net loss of $200. This is the maximum possible
loss and is suffered when the underlying stock price at expiration is anywhere
between $40 and $50.
The Iron Butterfly

The iron butterfly spread is a neutral strategy that is a combination of a bull put
spread and a bear call spread. It is a limited risk, limited profit trading strategy
that is structured for a larger probability of earning smaller limited profit when
the underlying stock is perceived to have a low volatility.

To setup an iron butterfly, the options trader buys a lower strike out-of-the-
money put, sells a middle strike at-the-money put, sells a middle strike at-the-
money call and buys another higher strike out-of-the-money call. This results in a
net credit to put on the trade

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes an iron
butterfly by buying a JUL 30 put for $50, writing a JUL 40 put for $300, writing
another JUL 40 call for $300 and buying another JUL 50 call for $50. The net
credit received when entering the trade is $500, which is also his maximum
possible profit.

On expiration in July, XYZ stock is still trading at $40. All the 4 options expire
worthless and the options trader gets to keep the entire credit received as profit.
This is also his maximum possible profit.

If XYZ stock is instead trading at $30 on expiration, all the options except the JUL
40 put sold expire worthless. The JUL 40 put will have an intrinsic value of $1000.
This option has to be bought back to exit the trade. Thus, subtracting his initial
$500 credit received, the options trader suffers his maximum possible loss of
$500. This maximum loss situation also occurs if the stock price had gone up to
$50 or beyond instead.

To further see why $500 is the maximum possible loss, lets examine what
happens when the stock price falls below $30 to $25 on expiration. At this price,
only the JUL 30 put and the JUL 40 put options expire in-the-money. The long JUL
30 put has an intrinsic value of $500 while the short JUL 40 put is worth $1500.
Selling the long put for $500, and factoring in the intial credit of $500 received,
he still need to fork out another $500 to buy back the short put worth $1500.
Thus his maximum loss is still $500.

The Iron Condor

The iron condor is a neutral strategy that is a combination of a bull put spread
and a bear call spread. It is a limited risk, limited profit trading strategy that is
structured for a larger probability of earning smaller limited profit when the
underlying stock is perceived to have a low volatility.

To setup an iron condor, the options trader sells a lower strike out-of-the-money
put, buys an even lower strike out-of-the-money put, sells a higher strike out-of-
the-money call and buys another even higher strike out-of-the-money call. This
results in a net credit to put on the trade.
Example
Suppose XYZ stock is trading at $45 in June. An options trader executes an iron
condor by buying a JUL 35 put for $50, writing a JUL 40 put for $100, writing
another JUL 50 call for $100 and buying another JUL 55 call for $50. The net
credit received when entering the trade is $100, which is also his maximum
possible profit.

On expiration in July, XYZ stock is still trading at $45. All the 4 options expire
worthless and the options trader gets to keep the entire credit received as profit.
This is also his maximum possible profit.

If XYZ stock is instead trading at $35 on expiration, all the options except the JUL
40 put sold expire worthless. The JUL 40 put has an intrinsic value of $500. This
option has to be bought back to exit the trade. Thus, subtracting his initial $100
credit received, the options trader suffers his maximum possible loss of $400.
This maximum loss situation also occurs if the stock price had gone up to $55
instead.

To further see why $400 is the maximum possible loss, lets examine what
happens when the stock price falls to $30 on expiration. At this price, both the
JUL 35 put and the JUL 40 put options expire in-the-money. The long JUL 35 put
has an intrinsic value of $500 while the short JUL 40 put is worth $1000. Selling
the long put for $500, he still need $500 to buy back the short put. Subtracting
the initial credit of $100 received, his loss is still $400.

Calendar Straddle

The calendar straddle is implemented by selling a near term straddle while buying
a longer term straddle with the intention to profit from the rapid time decay of
the near term options sold. It is a limited profit, limited risk strategy entered by
the options trader who thinks that the underlying stock price will experience very
little volatility in the near term.

Example

In June, an options trader believes that XYZ stock trading at $40 is going to trade
sideways over the next month or so. He enters a calendar straddle by buying an
OCT 40 call for $200 and an OCT 40 put for $200 while simultaneously writing a
JUL 40 call for $100 and a JUL 40 put for $100. The net investment required to
implement the strategy is a debit of $200.

On near-term option expiration in July, if the stock is still trading at $40, both the
written options will expire worthless while the long call and the long put will still
be worth $175 each due to a much slower time decay. Selling this long straddle
will net $350 to produce an overall profit of $150 after factoring in the $200 initial
debit taken.

If instead, the price of XYZ stock had skyrocketed to $60 in July, the written near
term straddle will be worth $2000 since the written put will expire worthless while
the written call now has an intrinsic value of $2000. The long straddle will also be
worth $2000 because while the put will be too far out-of-the-money to be worth
anything, the long call will be very deep in-the-money and be worth $2000 (time
value for the long call will be almost nothing since it is very deep in-the-money).
As such, the options trader can sell the long straddle to offset the losses from the
short straddle. Hence, his overall loss is the $200 from the initial debit taken to
enter the trade.
Greek

The Delta

The rate of change of the price of an option with respect to its underlying stock
price is known as the delta. The delta ranges in value from 0 to 1 for calls (0 to -1
for puts) and reflects the increase or decrease in the price of the option in
response to a 1 point movement of the underlying stock price.

Far out-of-the-money options have delta values close to 0 while deep in-the-
money options have deltas that are close to 1.

Up delta , down delta

As the delta can change even with very tiny movements of the underlying stock
price, it may be more practical to know the up delta and down delta values. For
instance, the price of a call option with delta of 0.5 may increase by 0.6 point on
a 1 point increase in the underlying stock price but decrease by only 0.4 point
when the underlying stock price goes down by 1 point. In this case, the up delta
is 0.6 and the down delta is 0.4.

Effects of time on the delta

As the time remaining to expiration grows shorter, the time value of the option
evaporates and correspondingly, the delta of in-the-money options increases
while the delta of out-of-the-money options decreases.

How volatility affects the delta

As volatility rises, the time value of the option goes up and this causes the delta
of out-of-the-money options to increase and the delta of in-the-money options to
decrease.

The Gamma

In options trading, gamma is a measure of the rate of change of the delta. The
gamma is expressed as a percentage and reflects the change in the delta in
response to a one point movement of the underlying stock price.

Like the delta, the gamma is constantly changing, even with tiny movements of
the underlying stock price. It generally is at its peak value when the stock price is
near the strike price of the option and decreases as the option goes deeper into
or out of the money. Options that are very deeply into or out of the money have
gamma values close to 0.

Example

Suppose for a stock XYZ, currently trading at $47, there is a FEB 50 call option
selling for $2 and let's assume it has a delta of 0.4 and a gamma of 0.1 or 10
percent. If the stock price moves up by $1 to $48, then the delta will be adjusted
upwards by 10 percent from 0.4 to 0.5.

However, if the stock trades downwards by $1 to $46, then the delta will
decrease by 10 percent to 0.3.
Effects of time on the gamma

As the time to expiration draws nearer, the gamma of at-the-money options

increases while the gamma of in-the-money and out-of-the-money options
decreases.

Gamma and volatility

When volatility is low, the gamma of at-the-money options is high while the
gamma for deeply into or out-of-the-money options approaches 0. This
phenomenon arises because when volatility is low, the time value of such options
are low but it goes up dramatically as the underlying stock price approaches the
strike price.

When volatility is high, gamma tends to be stable across all strike prices. This is
due to the fact that when volatility is high, the time value of deeply in/out-of-the-
money options are already quite substantial. Thus, the increase in the time value
of these options as they go nearer the money will be less dramatic and hence the
low and stable gamma.

The Theta

Theta is a measurement of the time decay of options. It is the rate at which

options lose their value, specifically the time value, as the expiration date draws
nearer. Generally expressed as a negative number, the theta reflects the amount
by which the option value will decrease every day.

Example
A call option with a current price of $2 and a theta of -0.05 will experience a drop
in price of $0.05 per day. So in two days' time, the price of the option should fall
to $1.90.

Effects of time on the theta

Longer term options have theta of almost 0 as they do not lose value on a daily
basis. Theta is higher for shorter term options, especially at-the-money options.
This is pretty obvious as such options have the highest time value and thus have
more premium to lose each day.

Conversely, theta goes up dramatically as options near expiration as time decay

is at its greatest during that period.

Volatility and its effect on the theta

In general, options of high volatility stocks have higher theta than low volatility
stocks. This is because the time value premium on these options are higher and
so they have more to lose per day.
The Vega

Vega is a measure of the impact of changes in the underlying volatility on the

option price. Specifically, the vega expresses the change in the price of the option
for every 1% change in underlying volatility.

Options tend to be more expensive when volatility is higher. Thus, whenever

volatility goes up, the price of the option goes up and when volatility drops, the
price of the option will also fall. Therefore, when calculating the new option price
due to volatility changes, we add the vega when volatility goes up but subtract it
when the volatility falls.

Example
A stock XYZ is trading at $46 in May and a JUN 50 call is selling for $2. Let's
assume that the vega of the option is 0.15 and that the underlying volatility is
25%.

If the underlying volatility increased by 1% to 26%, then the price of the option
should rise to $2 + 0.15 = $2.15.

However, if the volatility had gone down by 2% to 23% instead, then the option
price should drop to $2 - (2 x 0.15) = $1.70

Time to expiration and the vega

The more time remaining to option expiration, the higher the vega. This makes
sense as time value makes up a larger proportion of the premium for longer term
options and it is the time value that is sensitive to changes in volatility.
Dividend Arbitrage
This is an arbitrage strategy whereby the options trader buys both the stock and
the equivalent number of put options before ex-dividend and wait to collect the
dividend before exercising his put.

Example
XYZ stock is trading at $90 and is paying $2 in dividend tomorrow. A put with a
striking price of $100 is selling for $11. The options trader can enter a riskless
dividend arbitrage by purchasing both the stock for $9000 and the put for $1100
for a total of $10100.
On ex-dividend, he collects $200 in the form of dividends and exercises his put to
sell his stock for $10000, bringing in a total of $10200. Since his initial
investment is only $10100, he earns $100 in zero risk profits.

Conversion
A conversion is an arbitrage strategy in options trading that can be performed for
a riskless profit when options are overpriced relative to the underlying stock. To
do a conversion, the trader buys the underlying stock and offset it with an
equivalent synthetic short stock (long put + short call) position.

Example
Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at $4
while the JUL 100 put is priced at $3. An arbitrage trader does a conversion by
purchasing 100 shares of XYZ for $10000 while simultaneously buying a JUL 100
put for $300 and selling a JUL 100 call for $400. The total cost to enter the trade
is $10000 + $300 - $400 = $9900.
Assuming XYZ stock rallies to $110 in July, the long JUL 100 put will expire
worthless while the short JUL 100 call expires in the money and is assigned. The
trader then sells his long stock for $10000 as required. Since his cost is only
$9900, there is a $100 profit.
If instead XYZ stock had dropped to $90 in July, the short JUL 100 call will expire
worthless while the long JUL 100 put expires in the money. The trader then
exercises the long put to sell his long stock for $10000, again netting a profit of
$100.

Reversal
A reversal, or reverse conversion, is an arbitrage strategy in options trading that
can be performed for a riskless profit when options are underpriced relative to the
underlying stock. To do a reversal, the trader short sell the underlying stock and
offset it with an equivalent synthetic long stock (long call + short put) position.

Example
Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at $3
while the JUL 100 put is priced at $4. An arbitrage trader does a reversal by short
selling 100 shares of XYZ for $10000 while simultaneously buying a JUL 100 call
for $300 and selling a JUL 100 put for $400. An initial credit of $10100 is received
when entering the trade.
If XYZ stock rallies to $110 in July, the short JUL 100 put will expire worthless
while the long JUL 100 call expires in the money and is exercised to cover the
short stock position for $10000. Since the initial credit received was $10100, the
trader ends up with a net profit of $100.
If instead XYZ stock had dropped to $90 in July, the long JUL 100 call will expire
worthless while the short JUL 100 put expires in the money and is assigned. The
trader then buys back the obligated quantity of stock for $10000 to cover his
short stock position, again netting a profit of $100.