1. Options Basics: Introduction
  2. Options Basics: Call and Put Options
  3. Options Basics: Why Use Options?
  4. Options Basics: How Options Work
  5. Options Basics: Types of Options
  6. Options Basics: How to Read An Options Table
  7. Options Basics: Options Spreads
  8. Options Basics: Options Risks
  9. Options Basics: Conclusion

Options spreads are a common strategy and involve buying and selling options of the same or differing types, expirations, and strikes. You can also combine different options strategies, known as combinations. In this section, we will provide a very basic overview of the most common options spreads and combinations.

Long Calls/Puts, Straddles, and Strangles

The simplest options position is a long call (or put) by itself. This position profits if the price of the underlying rises (falls), and your downside is limited to loss of the option premium spent. If you simultaneously buy a call and put option with the same strike and expiration, you’ve created a straddle. This position pays off if the underlying price rises or falls dramatically; however if the price remains relatively stable, you lose premium on both the call and the put. You would enter this strategy if you expect a large move in the stock but are not sure which direction. Basically, you need the stock to have a move outside of a range. A similar strategy betting on an outsized move in a security  when you expect high volatility (uncertainty) is to buy a call and buy a put with different strikes and the same expiration - known as a strangle. A strangle requires larger price moves in either direction to profit, but is also less expensive than a straddle. On the other hand, being short either a straddle or a strangle (selling both options) would profit from a market that doesn’t move much.

Below is an explanation of straddles from my Options for Beginners course:

 

And here’s a description of strangles:

Call/Put Spreads and Butterflies

bull call spread, or bull call vertical spread, is created by buying a call and simultaneously selling another call with a higher strike price and the same expiration. The spread is profitable if the underlying asset increases in price, but the upside is limited due to the short call strike. The benefit, however, is that selling the higher strike call reduces the cost of buying the lower one. Similarly, a bear put spread, or bear put vertical spread, involves buying a put and selling a second put with a lower strike and the same expiration.

If you buy and sell options with different expirations, it is known as a calendar spread, or time spread.

butterfly consists of options at three strikes, equally spaced apart, where all options are of the same type (either all calls or all puts) and have the same expiration. In a long butterfly, the middle strike option is sold and the outside strikes are bought in a ratio of 1:2:1 (buy one, sell two, buy one). If this ratio does not hold, it is not a butterfly. The outside strikes are commonly referred to as the wings of the butterfly, and the inside strike as the body. The value of a butterfly can never fall below zero. An example of a butterfly would be to go long a 70 call, short two 75 calls, and long an 80 call. The identical spread could also be made with long the 70 put, short two 75 puts, and long an 80 put. Being long a butterfly profits from a quiet market. Similar to a butterfly are the condoriron butterfly, and iron condor. The butterfly gets its name from the shape of its profit-and-loss graph.

We addressed briefly how a synthetic position in the underlying can be created from options. Combining options positions with the underlying can also produce synthetic options. This has to do with what is known as put-call parity, where:

Call Price – Put Price = Underlying Price – Strike Price.

Rearranging this equation, we can create a synthetic long call for a given strike price by buying a put and also buying the underlying. Similarly, a synthetic put is a long call combined with going short the underlying. You can also create other combination strategies that include a trade in the underlying, such as a collar or risk reversal.


Options Basics: Options Risks
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