Chapter - 7
Option Strategy
7.1 Types of Option Strategy
1. Covered Call:
The term covered call refers to a financial transaction in which the
investor selling call options owns an equivalent amount of the
underlying security. To execute a covered call, an investor holding a
long position in an asset then writes (sells) call options on that same
asset.
Strategy:
Today: Purchase the stock and sell the call option
Total gain (loss) = Gain (loss) from stock + Gain (loss) from short call
= (ST − S0 ) + ( CP - TVC )
BEP = S0 - TVC
2. Protective Put
A protective put is a risk management and options strategy that
involves holding a long position in the underlying asset (e.g., stock)
and purchasing a put option with a strike price equal to or close to
the current price of the underlying asset. A protective put strategy is
also known as a synthetic call.
Strategy:
Today: Purchase the stock and purchase the put option
Total gain (loss) = Gain (loss) from stock + Gain (loss) from long put
= (ST − S0 ) + ( TVP − PP )
BEP = S0 + PP
3. Long Straddle
A long straddle is an options strategy where a trader buys a long call and a long
put on the same underlying asset with the same expiration date and strike or
exercise price.
Strategy:
Today: Purchase both call and put option
Total gain (loss) = Gain (loss) from long call + Gain (loss) from long put
= (TVC − CP ) + ( TVP − 𝑃𝑃 )
BEP = E + CP + PP
Or, BEP = E – CP - PP
4. Short Straddle
A short straddle is an options strategy comprised of selling both a call option and
a put option with the same exercise (strike) price and expiration date.
Strategy:
Today: Sell both call and put options
Total gain (loss) = Gain (loss) from short call + Gain (loss) from short put
= (CP − TVC ) + ( PP − TVP )
BEP = E + CP + PP
Or, BEP = E – CP - PP
5. Long Strangle
Long strangles involve buying a call with a higher exercise price and buying a
put with a lower exercise price. In the long straddle, an investor buys a call and
a put with the same strike price but in the long strangle buys calls and puts at
different strike prices.
Strategy:
Today: Purchase both call and put option
Total gain (loss) = Gain (loss) from long call + Gain (loss) from long put
= (TVC − CP ) + ( TVP − 𝑃𝑃 )
BEP = Higher exercise price + CP + PP
Or, BEP = Lower exercise price – CP - PP
6. Short Strangle
Short strangles involve selling a call with a higher exercise
price and selling a put with a lower exercise price.
Strategy:
Today: Sell both call and put options
Total gain (loss) = Gain (loss) from short call + Gain (loss) from short put
= (CP − TVC ) + ( PP − TVP )
BEP = Higher exercise price + CP + PP
Or, BEP = Lower exercise price – CP - PP
7. Long Strip
A long strip strategy consists of buying one long call and two long puts
at the same strike price for the same expiration date.
Strategy:
Today: Purchase one call and two put options
Total gain (loss) = Gain (loss) from long call + Gain (loss) from long put
= (TVC − CP ) + 2 ( TVP − 𝑃𝑃 )
8. Short Strip
A short strip would involve selling one call and two puts but this
strategy profits when the underlying assets do not move.
Today: Sell one call and two put options
Total gain (loss) = Gain (loss) from short call + Gain (loss) from short put
= (CP − TVC ) + 2 ( PP − TVP )
9. Long Strap
A long strap is a risk-defined, neutral-to-bullish strategy that consists of buying
two long calls and one long put at the same strike price for the same expiration
date.
Strategy:
Today: Purchase two calls and one put option
Total gain (loss) = Gain (loss) from long call + Gain (loss) from long put
= 2(TVC − CP ) + ( TVP − 𝑃𝑃 )
10. Short Strap
A short strip would involve selling two calls and one put at the same strike price
for the same expiration date.
Today: Sell two calls and one put options
Total gain (loss) = Gain (loss) from short call + Gain (loss) from short put
= 2(CP − TVC ) + ( PP − TVP )
11. Bull Call Spread Strategy
A bull call spread consists of one long call with a lower strike price and one short call
with a higher strike price. Both calls have the same underlying stock and the same
expiration date. A bull call spread is established for a net debit (or net cost) and profits
as the underlying stock rise in price.
Strategy:
Today: Purchase a call and sell a call option
Total gain (loss) = Gain (loss) from long call + Gain (loss) from short call
= (TVC − CP ) + (CP - TVC )
12. Bear Call Spread Strategy
A bear call spread, or a bear call credit spread, is a type of options strategy used when
an options trader expects a decline in the price of the assets. A bear call spread is
achieved by simultaneously selling a call option at a lower strike price and buying a call
option at a higher strike price but with the same expiration date.
Strategy: Sell a call and purchase a call option
Today: Total gain (loss) = Gain (loss) from short call + Gain (loss) from long call
= (CP − TVC ) + ( TVC − CP)
13. Collar Strategy
A collar is an options strategy that involves buying a downside put and selling an
upside call to protect against large losses, but that also limits large upside gains.
The protective collar strategy involves two strategies known as a protective put
and covered call.
Strategy:
Today: Purchase the stock, sell the call option, and purchase the put option
Total gain (loss) = Gain (loss) from stock + Gain (loss) from short call + Gain (loss) from long put
= (ST − S0 ) + ( CP - TVC ) + ( TVP − PP )
