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This web page is for those of you who are familiar with how stock options work.

 I have read all the books on complex option strategies. They are great for risk protection, especially if you own a stock and want insurance. If you own shares of a stock and they're getting battered, you either sell at a loss or keep them and hope they eventually go up in value. Options give you another strategy. Buy long term put options on that stock. When your stock goes down, your put options go up. With this strategy, you're always at least breaking even.

There are many complex option strategies. Below is a list of some of them. We like to keep things simple and uncomplicated, but some of you may want to combine some of these strategies with our picks. Be aware that most complex option strategies require a lot of money.

synthetic position: A strategy involving two or more instruments that has the same risk-reward profile as a strategy involving only one instrument. The following list summarizes the six primary synthetic positions.
 

synthetic long Call: A long stock position combined with a long Put of the same series as that Call.

synthetic long Put: A short stock position combined with a long Call of the same series as that Put.
 

synthetic long stock: A long Call position combined with a short Put of the same series.
 

synthetic short Call: A short stock position combined with a short Put of the same series as that Call.
 

synthetic short Put: A long stock position combined with a short Call of the same series as that Put.
 

synthetic short stock: A short Call position combined with a long Put of the same series.

straddle: A trading position involving Puts and Calls on a one-to-one basis in which the Puts and Calls have the same strike price, expiration, and underlying stock. A long straddle is when both options are owned and a short straddle is when both options are written. Example: a long straddle might be buying 1 XYZ May 60 Call, and buying 1 XYZ May 60 Put.

spread / spread order: A position consisting of two parts, each of which alone would profit from opposite directional price moves. As orders, these opposite parts are entered and executed simultaneously in the hope of (1) limiting risk, or (2) benefiting from a change of price relationship between the two parts.

time spread: An option strategy which generally involves the purchase of a farther-term option (Call or Put) and the writing of an equal number of nearer-term options of the same type and strike price. Example: buying 1 XYZ May 60 Call (far-term portion of the spread) and writing 1 XYZ March 60 Call (near-term portion of the spread). Also known as calendar spread or horizontal spread.

reversal / reverse conversion: An investment strategy used by professional option traders in which a short Put and long Call with the same strike price and expiration are combined with short stock to lock in a nearly risk less profit. For example, selling short 100 shares of XYZ stock, buying 1 XYZ May 60 Call, and writing 1 XYZ May 60 Put at favorable prices. The process of executing these three-sided trades is sometimes called "reversal arbitrage."

ratio spread: A term most commonly used to describe the purchase of an option(s), Call or Put, and the writing of a greater number of the same type of options that are out-of-the-money with respect to those purchased. All options involved have the same expiration date. For example, buying 5 XYZ May 60 Calls and writing 6 XYZ May 65 Calls.

bear spread (Call): The simultaneous writing of one Call option with a lower strike price and the purchase of another Call option with a higher strike price. Example: writing 1 XYZ May 60 Call, and buying 1 XYZ May 65 Call.
 

bear spread (Put): The simultaneous purchase of one Put option with a higher strike price and the writing of another Put option with a lower strike price. Example: buying 1 XYZ May 60 Put, and writing 1 XYZ May 55 Put.

box spread: A four-sided option spread that involves a long Call and a short Put at one strike price as well as a short Call and a long Put at another strike price. Example: buying 1 XYZ May 60 Call, and writing 1 XYZ May 65 Call; simultaneously buying 1 XYZ May 65 Put, and writing 1 May 60 Put.

bull (or bullish) spread: One of a variety of strategies involving two or more options (or options combined with an underlying stock position) that will profit from a rise in the price of the underlying stock.

bull spread (Call): The simultaneous purchase of one Call option with a lower strike price and the writing of another Call option with a higher strike price. Example: buying 1 XYZ May 60 Call, and writing 1 XYZ May 65 Call.
 

bull spread (Put): The simultaneous writing of one Put option with a higher strike price and the purchase of another Put option with a lower strike price. Example: writing 1 XYZ May 60 Put, and buying 1 XYZ May 55 Put.

butterfly spread: A strategy involving four options and three strike prices that has both limited risk and limited profit potential. A long Call butterfly is established by: buying one Call at the lowest strike price, writing two Calls at the middle strike price, and buying one Call at the highest strike price. A long Put butterfly is established by: buying one Put at the highest strike price, writing two Puts at the middle strike price, and buying one Put at the lowest strike price. For example, a long Call butterfly might be: buying 1 XYZ May 55 Call, writing 2 XYZ May 60 Calls and buying 1 XYZ May 65 Call.

collar: A protective strategy in which a written Call and a long Put are taken against a previously owned long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same. For example, if the investor previously purchased XYZ Corporation at $46 and it rose to $62, a "collar" involving the purchase of a May 60 Put and the writing of a May 65 Call could be established as a way of protecting some of the unrealized profit in the XYZ Corporation stock position. The reverse -- a long Call combined with a written Put -- might also be used if the investor has previously established a short stock position in XYZ Corporation. This strategy is also known as a fence.

combination: A trading position involving out-of-the-money Puts and Calls on a one-to-one basis. The Puts and Calls have different strike prices, but the same expiration and underlying stock. A long combination is when both options are owned, and a short combination is when both options are written. Example: a long combination might be buying 1 XYZ May 60 Call, and buying 1 XYZ May 55 Put.

condor spread: A strategy involving four options and four strike prices that has both limited risk and limited profit potential. A long Call condor spread is established by buying one Call at the lowest strike, writing one Call at the second strike, writing another Call at the third strike, and buying one Call at the fourth (highest) strike. This spread is also referred to as a "flat-top butterfly."

covered straddle: An option strategy in which one Call and one Put with the same strike price and expiration are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 Call and 1 XYZ May 60 Put, and buying 100 shares of XYZ stock. In actuality, this is not a fully "covered" strategy because assignment on the short Put would require purchase of additional stock.

covered combination: A strategy in which one Call and one Put with the same expiration, but different strike prices, are written against each 100 shares of the underlying stock. Example: writing 1 XYZ May 60 Call and 1 XYZ May 65 Put, and buying 100 shares of XYZ stock. In actuality, this is not a fully "covered" strategy because assignment on the short Put would require purchase of additional stock.

diagonal spread: A strategy involving the simultaneous purchase and writing of two options of the same type that have different strike prices and different expiration dates. Example: buying 1 May 60 Call and writing 1 March 65 Call.

iron butterfly: An option strategy with limited risk and limited profit potential that involves both a long (or short) straddle, and a short (or long) combination. An iron butterfly contains four options as is an equivalent strategy to a regular butterfly spread which contains only three options. For example, a short iron butterfly might be: buying 1 XYZ May 60 Call and 1 May 60 Put, and writing 1 XYZ May 65 Call and writing 1 XYZ May 55 Put.

This is only a small sample of the hundreds of option strategies out there. Trust me, keep it simple.









 

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Last modified: May 12, 2007