Long Call:
Trade: Buy 1 ITM call option
Maximum Profit = Unlimited
Profit Achieved When Price of Underlying is greater than or equal to Strike Price of Long Call + Premium Paid
Profit = Price of Underlying - Strike Price of Long Call - Premium Paid
Max Loss = Premium Paid + Commissions Paid
Max Loss Occurs When Price of Underlying <= Strike Price of Long Call
Breakeven Point = Strike Price of Long Call + Premium Paid
Example
Suppose the stock of XYZ Company with lot size 100 is trading at $40. A call option contract with a strike price of $40 expiring in a month's time is being priced at $2. You believe that XYZ stock will rise sharply in the coming weeks and so you paid =100* $2 to purchase a single $40 XYZ call option.
Profit: On expiry if XYZ closed above 40 $. If XYZ closed at 50$, your profit =100*50-100*(40+2) = 800 $
Loss: if XYZ closes below 40 $, maximum loss is premium paid. If XYZ closes on 41, you get 100 $
Breakeven Point = 40+2=42$
Buying Out-of-the-money Calls
Going long on Out-of-the-money Calls maybe cheaper but the call options have higher risk of expiring worthless.
Buying In-the-money Calls
In-the-money calls are more expensive than out-of-the-money calls chances of getting premium paid back are more
Bull Call Spread
Trade: Buy 1 ITM call option + sell 1 OTM Call
Maximum Profit = Unlimited
Profit Achieved When Price of Underlying is greater than or equal to Strike Price of Long Call + Premium Paid
Profit = Price of Underlying - Strike Price of Long Call - Premium Paid
Risk:
Max Loss = Premium Paid + Commissions Paid
Max Loss Occurs When Price of Underlying <= Strike Price of Long Call
Breakeven Point = Strike Price of Long Call + Premium Paid
The bull call spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go up moderately in the near term.
Bull call spreads can be implemented by buying an at-the-money call option while simultaneously writing a higher striking out-of-the-money call option of the same underlying security and the same expiration month.
By shorting the out-of-the-money call, the options trader reduces the cost of establishing the bullish position but forgoes the chance of making a large profit in the event that the underlying asset price skyrockets. The bull call spread option strategy is also known as the bull call debit spread as a debit is taken upon entering the trade
- Max Profit = Strike Price of Short Call - Strike Price of Long Call - Net Premium Paid - Commissions Paid
- Max Profit Achieved When Price of Underlying >= Strike Price of Short Call
- Max Loss = Net Premium Paid + Commissions Paid
- Max Loss Occurs When Price of Underlying <= Strike Price of Long Call
Breakeven Point = Strike Price of Long Call + Net Premium Paid
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 (Selling ) 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.
One can enter a more aggressive bull spread position by widening the difference between the strike price of the two call options. However, this will also mean that the stock price must move upwards by a greater degree for the trader to realise the maximum profit.
Bull Put Spread:
The bull put spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go up moderately in the near term. The bull put spread options strategy is also known as the bull put credit spread as a credit is received upon entering the trade
Bull put spreads can be implemented by selling a higher striking in-the-money put option and buying a lower striking out-of-the-money put option on the same underlying stock with the same expiration date.
If the stock price closes above the higher strike price on expiration date, both options expire worthless and the bull put spread option strategy earns the maximum profit which is equal to the credit taken in when entering the position.
Profit:
- Max Profit = Net Premium Received - Commissions Paid
- Max Profit Achieved When Price of Underlying >= Strike Price of Short Put
Risk:
If the stock price drops below the lower strike price on expiration date, then the bull put spread strategy incurs a maximum loss equal to the difference between the strike prices of the two puts minus the net credit received when putting on the trade.
- Max Loss = Strike Price of Short Put - Strike Price of Long Put Net Premium Received + Commissions Paid
- Max Loss Occurs When Price of Underlying <= Strike Price of Long Put
Breakeven Point = Strike Price of Short Put - Net Premium Received
Example:
An options trader believes that XYZ stock trading at $43 is going to rally soon and enters a bull put spread by buying a JUL 40 put for $100 and writing a JUL 45 put for $300. Thus, the trader receives a net credit of $200 when entering the spread position.
The stock price of XYZ begins to rise and closes at $46 on expiration date. Both options expire worthless and the options trader keeps the entire credit of $200 as profit, which is also the maximum profit possible.
If the price of XYZ had declined to $38 instead, both options expire in-the-money with the JUL 40 call having an intrinsic value of $200 and the JUL 45 call having an intrinsic value of $700. This means that the spread is now worth $500 at expiration. Since the trader had received a credit of $200 when he entered the spread, his net loss comes to $300. This is also his maximum possible loss.
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.
Profit:
The call back spread profits when the stock price makes a strong move to the upside beyond the upper breakeven point. There is no limit to the maximum possible profit.
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying >= 2 x Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/Received
- Profit = Price of Underlying - Strike Price of Long Call - Max Loss
Risk:
Maximum loss for the call back spread is limited and is taken when the underlying stock price at expiration is at the strike price of the long calls purchased. At this price, both the long calls expire worthless while the short call expires in the money. Maximum loss is equal to the intrinsic value of the short call plus or minus any debit or credit taken when putting on the spread.
- Max Loss = Strike Price of Long Call - Strike Price of Short Call +/- Net Premium Paid/Received + Commissions Paid
- Max Loss Occurs When Strike Price of Long Call
Breakeven point(s):
There are 2 break-even points for the call backspread position. The breakeven points can be calculated using the following formulae.
- Upper Breakeven Point = Strike Price of Long Call + Points of Maximum Loss
- Lower Breakeven Point = Strike Price of Short Call
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 t his 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.
Trade: Sell 1 Near Term OTM Call + Buy 1 Long Term ATM Call
Profit: Unlimited
Once the near month options expire worthless, this strategy turns into a discounted long call strategy and so the upside profit potential for the bull calendar spread becomes unlimited.
Risk:
The maximum possible loss for the bull calendar spread is limited to the initial debit taken to put on the spread. This happens when the stock price goes down and stays down until expiration of the longer term call.
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.
Naked puts:
strategy involving the selling of put options
Trade: Sell 1 ATM Put
Profit: Limited
- Max Profit = Premium Received - Commissions Paid
- Max Profit Achieved When Price of Underlying >= Strike Price of Short Put
Risk:
- Maximum Loss = Unlimited
- Loss Occurs When Price of Underlying < Strike Price of Short Put - Premium Received
- Loss = Strike Price of Short Put - Price of Underlying - Premium Received + Commissions Paid
Breakeven Point = Strike Price of Short Put - Premium Received
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
