Level 3 Options Trading: Explaining Advanced Options Strategies

Options offer traders remarkable flexibility, allowing them to both hedge risk and pursue growth. Because of this, they can be a valuable tool in achieving your portfolio objectives for manual and algorithmic traders. And with our recent launch of Level 3 options in live, this resource will highlight several of the options trading strategies available through both Alpaca’s Trading API and dashboard.

Remember that options trading involves risk, including the potential loss of your entire investment, and in some cases, even more. Therefore, thorough research and understanding of the various strategies are essential before you begin.

What Is Level 3 Options Trading?

Level 3 options trading involves utilizing advanced strategies with multiple options contracts in one trade to create specific risk and reward profiles. Also known as multi-leg options, these strategies are often complex and require a deep understanding of options pricing and market dynamics.

Advanced options trading strategies are typically employed by experienced investors who are seeking to fine-tune their positions to specific market conditions. Some common Level 3 options trading strategies include iron condors and iron butterflies, straddles, strangles, calendar spreads, credit spreads, and more. Watch our YouTube tutorial on how to trade multi-leg options through Alpaca’s Trading API or read our guide.

These strategies allow traders to take advantage of various market expectations, such as volatility, time decay (also known as theta decay), or price direction. They often have defined risk but a capped profit potential, making them appeal to traders who want to limit their potential losses.

However, they also come with increased complexity and risk, typically making them less suitable for new or novice traders. Having a fundamental knowledge of calls and puts, moneyness, and option Greeks is important before trading these advanced options strategies.

Level 3 Options Trading Requirements at Alpaca

Before live trading Level 3 options with Alpaca, you will need to be approved. This is a simple process that requires your basic financial information as well as proof that you understand the basics of these more advanced strategies. Traders looking to test multi-leg options strategies in Alpaca’s Paper Trading environment are auto approved. Read our tutorial on how to start trading options with Alpaca for more.

Call Credit Spread

What is a call credit spread?

A call credit spread, also known as a bear call spread or short call spread, involves selling one call option with a lower strike price and simultaneously buying another call option with a higher strike price on the same underlying asset and with the same expiration date. The term "credit" refers to the net premium received when establishing the position, as the premium received from the sold call (lower strike) exceeds the cost of the purchased call (higher strike).

When to use it

Call credit spreads are a bearish options strategy that can be used to potentially generate profit when you expect the underlying asset's price to stay below the lower strike price before expiration. This could be due to an anticipated downward trend, a belief that the price will remain relatively flat, or a desire to hedge against potential losses in another position.

Building the strategy

To construct a call credit spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe could either decrease in price or experience minimal upward movement.
2. Choose an expiration date: Determine a time frame that aligns with your price expectations.
3. Select strike prices: Choose two strike prices. The lower strike price should be below the current market price, and the higher strike price should be above the current price (typically both are out-of-the-money (OTM). The distance between the strikes will impact your risk/reward profile.
4. Execute the trade: Sell the call option with the lower strike price and simultaneously buy the call option with the higher strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is generally limited to the difference between the strike prices minus the net credit received.
• Potential for profit: If the underlying price stays below the lower strike price at expiration, both options expire worthless and you keep the net credit received as profit.
• Benefits from theta decay: As time passes, the value of options tends to decrease, which works in your favor with this strategy.

Cons:

• Limited profit potential: The theoretical maximum profit is capped at the net credit received when initiating the trade.
• Requires price to stay below the short strike: To achieve the potential maximum profit, the underlying price needs to remain below the lower strike price at expiration.
• Potential for unlimited loss if uncovered: If the short call is uncovered (meaning you don't own the underlying asset), the potential loss can be significant if the underlying price rises dramatically. However, oftentimes, the long call can be exercised to fulfill the obligation if the short call is assigned.

Risks:

• Assignment risk: If the underlying price moves above the lower strike price and your short call is assigned, you may be obligated to sell the underlying asset, even if you don't own it. This risk could be mitigated by owning the underlying asset or by closing the spread before assignment.
• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.

Example scenario (with theoretical P/L calculations)

Let's say XYZ stock is trading at $100. You believe it will stay below $105 in the next month. You decide to implement a call credit spread:

• Sell: 1 XYZ call option with a strike price of $105 for $2.00 per share ($200 total).
• Buy: 1 XYZ call option with a strike price of $110 for $0.50 per share ($50 total).
• Net credit: $200 - $50 = $150 (theoretical maximum profit)
• Theoretical maximum loss: -($110 - $105) x 100 + $150 = -$500 + $150 = -$350
• Breakeven point: $105 + $1.50 = $106.50

Scenario 1: XYZ price at expiration is $103

• Both calls expire worthless.
• Net profit: $150 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $107

• Your short call is in-the-money (ITM), but your long call is OTM.
• Your short call is assigned, and you are obligated to sell 100 shares of XYZ at $105, even though the market price is $107. This results in a $200 loss.
• Net profit: -$200 + $150 (initial credit) = -$50 loss

Scenario 3: XYZ price at expiration is $112

• Both calls are ITM.
• You exercise your long call to buy XYZ at $110 and are assigned on your short call, forcing you to sell XYZ at $105. This results in a $500 loss.
• Net loss: -$500 + $150 (initial credit) = -$350 (theoretical maximum loss)

These examples illustrate how profit and loss are typically capped in a call credit spread.

Call Debit Spread

What is a call debit spread?

A call debit spread, also known as a bull call spread, involves buying one call option with a lower strike price and simultaneously selling another call option with a higher strike price on the same underlying asset and with the same expiration date. The term "debit" comes from the fact that the trader pays a net premium to establish this position, as the cost of the purchased call (lower strike) exceeds the premium received from the sold call (higher strike).

When to use it

Call debit spreads are a bullish options strategy that profits when you anticipate a moderate increase in the underlying asset's price but want to limit your risk and cost of entry compared to simply buying a long call. They offer a defined risk and a capped profit potential, making them attractive to traders who want to limit their downside while participating in upward price movements.

Building the strategy

To construct a call debit spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will moderately increase in price.
2. Choose an expiration date: Determine a time frame that aligns with your price expectations.
3. Select strike prices: Choose two strike prices. The lower strike price should be below the current market price (or slightly above if you want to be more aggressive), and the higher strike price should be above the current price, reflecting your profit target.
4. Execute the trade: Buy the call option with the lower strike price and simultaneously sell the call option with the higher strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is limited to the net debit paid when entering the trade.
• Capped profit potential: The theoretical maximum profit is the difference between the strike prices minus the net debit paid.
• Lower cost: Compared to buying a single call option, the debit spread reduces the upfront cost due to the premium received from selling the higher strike call.

Cons:

• Limited profit potential: Your profit is capped, even if the underlying price significantly exceeds the higher strike price.
• Theta decay: Like all options, the value of the spread erodes as time passes, working against you.
• Requires price movement: To profit, the underlying price must rise above the breakeven point (lower strike price + net debit).

Risks:

• Max loss: Although the theoretical maximum loss is limited, it can still be substantial if the underlying price falls significantly.
• Assignment risk: If the short call is assigned, you may be obligated to sell the underlying asset, even if you don't own it. This risk is mitigated if the spread is created with calls on an asset you already own.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will rise to around $55 in the next month. You decide to implement a call debit spread:

• Buy: 1 XYZ call option with a strike price of $52 for $3.00 per share ($300 total).
• Sell: 1 XYZ call option with a strike price of $55 for $1.00 per share ($100 total).
• Net debit: -$300 + $100 = -$200 (theoretical maximum loss)
• Theoretical maximum profit: ($55 - $52) x 100 - $200 = $300 - $200 = $100
• Breakeven point: $52 + $2.00 = $54.00

Scenario 1: XYZ price at expiration is $60

• Both calls are ITM.
• Your short call may be assigned, forcing you to sell XYZ at $55. You exercise your long call to buy the share at $52 to cover the assignment, making $300 profit.
• Net profit: $5500 - $5200 - $200 (initial debit) = $100 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $53

• Your long call is ITM, but your short call is OTM.
• You exercise your long call to buy XYZ at $52 and sell it at the market price of $53, making a $100 profit.
• Net loss: $100 - $200 (initial debit) = -$100 loss

Scenario 3: XYZ price at expiration is $48

• Both calls expire worthless.
• Net loss: -$200 (theoretical maximum loss)

This example illustrates how the profit and loss are capped in a call debit spread.

Put Credit Spread

What is a put credit spread?

A put credit spread, also known as a bull put spread or short put spread, involves selling one put option with a higher strike price and simultaneously buying another put option with a lower strike price on the same underlying asset and with the same expiration date. The term "credit" refers to the net premium received when establishing the position, as the premium received from the sold put (higher strike) exceeds the cost of the purchased put (lower strike).

When to use it

Put credit spreads are a bullish options strategy that can be used to potentially generate profit when you expect the underlying asset's price to stay above the higher strike price before expiration. This could be due to an anticipated upward trend, a belief that the price will remain relatively flat, or a desire to possibly generate profit while hedging against potential losses in another position.

Building the strategy

To construct a put credit spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will either increase in price or experience minimal downward movement.
2. Choose an expiration date: Determine a time frame that aligns with your price expectations.
3. Select strike prices: Choose two strike prices. The higher strike price should be below the current market price, and the lower strike price should be further below the current price (typically both are OTM). The distance between the strikes will impact your risk/reward profile.
4. Execute the trade: Sell the put option with the higher strike price and simultaneously buy the put option with the lower strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is generally limited to the difference between the strike prices minus the net credit received.
• Potential for profit: If the underlying price stays above the higher strike price at expiration, both options expire worthless and you keep the net credit received as profit.
• Benefits from theta decay: As time passes, the value of options tends to decrease, which works in your favor with this strategy.

Cons:

• Limited profit potential: The theoretical maximum profit is capped at the net credit received when initiating the trade.
• Requires price to stay above the short strike: To achieve the potential maximum profit, the underlying price needs to remain above the higher strike price at expiration.

Risks:

• Assignment risk: American-style options can be assigned early, potentially disrupting the strategy. And if the underlying price moves below the higher strike price and your short put is assigned, you may be obligated to buy the underlying asset. This risk can be mitigated by having sufficient capital to purchase the shares or by closing the spread before assignment.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will stay above $45 in the next month. You decide to implement a put credit spread:

• Sell: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Buy: 1 XYZ put option with a strike price of $40 for $0.50 per share ($50 total).
• Net credit: $200 - $50 = $150 (theoretical maximum profit)
• Theoretical maximum loss: (-$45 + $40) x 100 + $150 = -$500 + $150 = - $350
• Breakeven point: $45 - $1.50 = $43.50

Scenario 1: XYZ price at expiration is $48

• Both puts expire worthless.
• Net profit: $150 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $43

• Your short put is ITM, but your long put is OTM.
• Your short put is assigned, and you are obligated to buy 100 shares of XYZ at $45, even though the market price is $43. This results in a $200 loss.
• Net profit: -$200 + $150 (initial credit) = -$50 loss

Scenario 3: XYZ price at expiration is $38

• Both puts are ITM.
• You exercise your long put to sell XYZ at $40 and are assigned on your short put, forcing you to buy XYZ at $45. This results in a $500 loss.
• Net loss: -$500 + $150 (initial credit) = -$350 (theoretical maximum loss)

This example illustrates how the profit and loss are typically capped in a put credit spread.

Put Debit Spread

What is a put debit spread?

A put debit spread, also known as a bear put spread, involves buying one put option with a higher strike price and simultaneously selling another put option with a lower strike price on the same underlying asset and with the same expiration date. The term "debit" refers to the net premium paid when entering the trade, as the cost of the purchased put (higher strike) exceeds the premium received from the sold put (lower strike).

When to use it

This strategy may be ideal when you anticipate a moderate decrease in the underlying asset's price but want to limit your risk and cost of entry compared to simply buying a long put. You might employ a put debit spread when you believe the underlying price will fall below the higher strike price but stay above the lower strike price before expiration.

Building the strategy

To construct a put debit spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will moderately decrease in price.
2. Choose an expiration date: Determine a time frame that aligns with your price expectations.
3. Select strike prices: Choose two strike prices. The higher strike price should be above the current market price (or slightly below if you want to be more aggressive), and the lower strike price should be below the current price, reflecting your profit target.
4. Execute the trade: Buy the put option with the higher strike price and simultaneously sell the put option with the lower strike price.

Pros, cons, and risks

Pros:

• Defined risk: The potential loss is generally limited to the net debit paid when entering the trade.
• Capped profit potential: The maximum profit is theoretically the difference between the strike prices minus the net debit paid.
• Lower cost: Compared to buying a single put option, the debit spread can reduce the upfront cost due to the premium received from selling the lower strike put.

Cons:

• Limited profit potential: Your profit is capped, even if the underlying price falls significantly below the lower strike price.
• Theta decay: Like all options, the value of the spread typically erodes as time passes, which can work against you.
• Requires price movement: To profit, the underlying price must fall below the breakeven point (higher strike price - net debit).

Risks:

• Theoretical Max loss: Although the maximum loss is typically limited, it can still be substantial if the underlying price rises significantly.
• Assignment risk: If the short put is assigned, you may be obligated to buy the underlying asset. This risk can be mitigated by having sufficient capital to purchase the shares or by closing the spread before assignment.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will fall to around $45 in the next month. You decide to implement a put debit spread:

• Buy: 1 XYZ put option with a strike price of $48 for $3.00 per share ($300 total).
• Sell: 1 XYZ put option with a strike price of $45 for $1.00 per share ($100 total).
• Net debit: -$300 + $100 = -$200 (theoretical maximum loss)
• Theoretical maximum profit: ($48 - $45) x 100 - $200 = $300 - $200 = $100
• Breakeven point: $48 - $2.00 = $46.00

Scenario 1: XYZ price at expiration is $40

• Both puts are ITM.
• You exercise your long put to sell XYZ at $48 and are assigned on your short put, forcing you to buy XYZ at $45. This results in a $300 profit.
• Net profit: $300 - $200 (initial debit) = $100 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $47

• Your long put is ITM, but your short put is OTM.
• You exercise your long put to sell XYZ at $48 and buy it at the market price of $47, making a $100 profit.
• Net profit: $100 - $200 (initial debit) = -$100 loss

Scenario 3: XYZ price at expiration is $52

• Both puts expire worthless.
• Net loss: -$200 (theoretical maximum loss)

This example illustrates how the profit and loss are typically capped in a put debit spread.

Long Straddle

What is a long straddle?

A long straddle involves buying both a call option and a put option with the same strike price and expiration date on the same underlying asset. This strategy is "long" because you are buying both options, not selling them.

When to use it

This strategy is best suited for situations where you anticipate a significant price move but are unsure of its direction. This could be in anticipation of an event like an earnings announcement, a major product release, or a pending legal decision that could significantly impact the underlying asset's price.

Building the strategy

To construct a long straddle, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a large price swing.
2. Choose an expiration date: Select an expiration date that aligns with the expected timing of the price movement.
3. Select a strike price: Choose a strike price that is at-the-money (ATM) or close to the current market price of the underlying asset.
4. Execute the trade: Buy one call option and one put option with the same strike price and expiration date.

Pros, cons, and risks

Pros:

• Profit potential in both directions: You can potentially profit whether the underlying price moves significantly up or down.
• Defined risk: The theoretical maximum loss is limited by a long call option and a long put option when entering the trade.
• No need to predict direction: You don't need to be right about the direction of the price move, only that a large move will occur.

Cons:

• Significant upfront cost: You need to pay the premiums for both the call and put options, which can be expensive.
• Theta decay: The value of both options erodes as time passes, working against you if the price doesn't move significantly.
• Requires substantial price movement: To profit, the underlying price must move beyond the breakeven points (strike price + total premium for the upside breakeven and strike price - total premium for the downside breakeven).

Risks:

• Theoretical maximum loss: The maximum loss is generally limited to the total premium paid for both options.
• Volatility crush: If the anticipated volatility does not materialize after the event, the value of both options can decline rapidly, leading to significant losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You expect a significant price swing after its earnings announcement next week. You decide to implement a long straddle:

• Buy: 1 XYZ call option with a strike price of $50 for $3.00 per share ($300 total).
• Buy: 1 XYZ put option with a strike price of $50 for $2.50 per share ($250 total).
• Net debit: -$300 - $250 = -$550 (theoretical maximum loss)
• Upside breakeven point: $50 + $5.50 = $55.50
• Downside breakeven point: $50 - $5.50 = $44.50

Scenario 1: XYZ price at expiration is $60

• The call option is ITM, and the put option expires worthless.
• You exercise your call to buy XYZ at $50 and sell it at the market price of $60, making a $1,000 profit.
• Net profit: $1,000 - $550 (total premium) = $450

Scenario 2: XYZ price at expiration is $40

• The put option is ITM, and the call option expires worthless.
• You exercise your put to sell XYZ at $50 and buy it at the market price of $40, making a $1,000 profit.
• Net profit: $1,000 - $550 (total premium) = $450

Scenario 3: XYZ price at expiration is $52

• Both options are ITM, but the profit from exercising either option is less than the total premium paid.
• Net loss: If we exercise the long call option to acquire 100 shares of XYZ at $50 (50 × 100 = -$5,000) and sell them in the market at $52 (52 × 100 = +$5,200), we would gain a $200 profit. Subtracting the initial debit of $500, this reduces the loss to $300.

Scenario 4: XYZ price at expiration is $50

• Both options expire worthless.
• Net loss: -$550 (theoretical maximum loss)

This example illustrates the potential for profit in both directions with a long straddle.

Long Strangle

What is a long strangle?

A long strangle involves simultaneously buying an OTM call option and an OTM put option with the same expiration date on the same underlying asset. This strategy is "long" because you are buying both options, not selling them. It essentially bets on volatility, regardless of whether the price goes up or down significantly.

When to use it

Similar to the long straddle, the long strangle is a volatility strategy that aims to profit from a significant price move in the underlying asset, but unlike the straddle, the direction of the move is less important. This could be in anticipation of an event like an earnings announcement, a major product release, or economic data that could significantly impact the underlying asset's price, but where the direction of the impact is unclear.

Building the strategy

To construct a long strangle, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a large price swing.
2. Choose an expiration date: Select an expiration date that aligns with the expected timing of the price movement.
3. Select strike prices: Choose two strike prices: one for the call (above the current market price) and one for the put (below the current market price). The further OTM the options are, the lower the cost of the strategy, but the larger the price move needed to profit.
4. Execute the trade: Buy one call option and one put option with the chosen strike prices and the same expiration date.

Pros, cons, and risks

Pros:

• Profit potential in both directions: You can profit whether the underlying price moves significantly up or down.
• Defined risk: The theoretical maximum loss is limited by a long call option and a long put option when entering the trade.
• Lower cost than a straddle: Because you're buying OTM options, the premiums are generally lower than for a straddle, which uses ATM options.

Cons:

• Requires a larger price move to profit: Since both options are OTM, the underlying price needs to move more significantly to reach profitability compared to a straddle.
• Theta decay: The value of both options erodes as time passes, working against you if the price doesn't move significantly.
• Higher risk of loss: Because of the larger price move required, there's a higher probability that the price won't move enough, and you'll lose your entire premium.

Risks:

• Theoretical maximum loss: The maximum loss is generally limited to the total premium paid for both options.
• Volatility crush: If the anticipated volatility does not materialize after the event, the value of both options can decline rapidly, leading to significant losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You expect a significant price swing after its earnings announcement next week, but you're unsure of the direction. You decide to implement a long strangle:

• Buy: 1 XYZ call option with a strike price of $55 for $2.00 per share ($200 total).
• Buy: 1 XYZ put option with a strike price of $45 for $1.50 per share ($150 total).
• Net debit: -$200 - $150 = -$350 (theoretical maximum loss)
• Upside breakeven point: $55 + $3.50 = $58.50
• Downside breakeven point: $45 - $3.50 = $41.50

Scenario 1: XYZ price at expiration is $65

• The call option is ITM, and the put option expires worthless.
• You exercise your call to buy XYZ at $55 and sell it at the market price of $65, making a $1,000 profit.
• Net profit: $1,000 - $350 (total premium) = $650

Scenario 2: XYZ price at expiration is $40

• The put option is ITM, and the call option expires worthless.
• You exercise your put to sell XYZ at $45 and buy it at the market price of $40, making a $500 profit.
• Net profit: $500 - $350 (total premium) = $150

Scenario 3: XYZ price at expiration is $52

• Both options expire worthless.
• Net loss: -$350 (theoretical maximum loss)

This example illustrates the potential for profit in both directions with a long strangle.

Long Call Calendar Spread

What is a long calendar call spread?

The long calendar call spread, also known as a time spread or horizontal spread, is a neutral to mildly bullish options strategy. It aims to capitalize on the difference in theta decay between the two options and an increase in implied volatility. Since options lose value as they approach expiration, the shorter-term option will decay faster than the longer-term option. This allows the trader to potentially profit if the underlying asset's price remains relatively stable or experiences a moderate increase.

When to use it

This strategy may be suitable when you expect the underlying asset's price to stay near the strike price of the options, particularly around the expiration date of the short-term option. This allows you to potentially benefit from the rapid theta decay of the short-term option while maintaining a longer-term bullish outlook with the longer-term option.

Building the strategy

To construct a long calendar call spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience minimal price movement or a moderate increase.
2. Choose expiration dates: Select two expiration dates. The first expiration date should be relatively short-term (e.g., a few weeks), while the second expiration date should be longer-term (e.g., a few months).
3. Select a strike price: Choose a strike price that is near the current market price of the underlying asset.
4. Execute the trade: Buy one longer-term call option and sell one shorter-term call option with the same strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is generally limited to the net debit paid when entering the trade.
• Potential for profit from theta decay: The strategy benefits from the faster theta decay of the short-term option.
• Benefits from increased volatility: An increase in implied volatility can increase the value of both options, further benefiting the spread.

Cons:

• Limited profit potential: The theoretical maximum profit is limited and depends on various factors, including the price of the underlying asset and implied volatility.
• Requires price stability or moderate increase: To potentially maximize profit, the underlying price needs to be near the strike price at the expiration of the short-term option.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Loss if the price moves significantly: If the underlying price moves significantly away from the strike price, the spread can lose value.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will stay near this price in the coming weeks but could increase moderately in the longer term. You decide to implement a long calendar call spread:

• Buy: 1 XYZ call option with a strike price of $50 expiring in 2 months for $4.00 per share ($400 total).
• Sell: 1 XYZ call option with a strike price of $50 expiring in 1 month for $2.00 per share ($200 total).
• Net debit: -$400 + $200 = -$200 (theoretical maximum loss)

Scenario 1: XYZ price at the first expiration (1 month) is $50

• The short-term call expires worthless.
• You keep the $200 premium from the short-term call and still hold the longer-term call, which now has more time value.
• Theoretical maximum profit: The value of the remaining long-term call, which will depend on the time to expiration and implied volatility.

Scenario 2: XYZ price at the first expiration (1 month) is $60

• The short-term sold call is ITM and may be assigned.
• You may need to buy 100 shares of XYZ at $60 to cover the assignment if you don’t own the shares.
• It would be safe to compare the market price of the long call (intrinsic + time value) to its intrinsic value alone.
  • If the long call has no time value (small vega), exercise it to acquire the shares at $50 and reduce your total loss.
  • If the long call has little or no remaining time value (extrinsic value), exercise it to acquire the shares at $50 and reduce your total loss.
  • If the long call retains significant time value, sell it in the market to capture its full premium. Then, use the proceeds to manage the assignment.
• Theoretical profit or loss: If you exercise the long call, the loss from buying and selling the XYZ shares becomes $0, but the initial loss of $200 remains as your total loss.

Scenario 3: XYZ price at the first expiration (1 month) is $40

• Both calls are OTM.
• The short-term call expires worthless, but the value of the long-term call has decreased.
• Theoretical maximum loss: The difference between the initial debit and the value of the remaining long-term call.

This example illustrates the potential outcomes of a long calendar call spread.

Long Put Calendar Spread

What is a long put calendar spread?

Also known as a time spread or horizontal spread, the long put calendar spread is a neutral to mildly bearish options strategy that profits primarily from theta decay and an increase in implied volatility. Since options lose value as they approach expiration, the shorter-term option will decay faster than the longer-term option. It involves buying a longer-term put option and selling a shorter-term put option with the same strike price on the same underlying asset.

When to use it

This strategy may be suitable when you expect the underlying asset's price to stay near the strike price of the options, particularly around the expiration date of the short-term option. This allows you to potentially benefit from the rapid theta decay of the short-term option while maintaining a longer-term bearish or neutral outlook with the longer-term option.

Building the strategy

To construct a long put calendar spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience minimal price movement or a moderate decrease.
2. Choose expiration dates: Select two expiration dates. The first expiration date should be relatively short-term (e.g., a few weeks), while the second expiration date should be longer-term (e.g., a few months).
3. Select a strike price: Choose a strike price that is near the current market price of the underlying asset.
4. Execute the trade: Buy one longer-term put option and sell one shorter-term put option with the same strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is generally limited to the net debit paid when entering the trade.
• Potential for profit from theta decay: The strategy benefits from the faster theta decay of the short-term option.
• Benefits from increased volatility: An increase in implied volatility can increase the value of both options, further benefiting the spread.

Cons:

• Limited profit potential: The theoretical maximum profit is limited and depends on various factors, including the price of the underlying asset and implied volatility.
• Requires price stability or moderate decrease: To maximize profit, the underlying price needs to be near the strike price at the expiration of the short-term option.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Potential for loss if the price moves significantly: If the underlying price moves significantly away from the strike price, the spread can lose value.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will stay near this price in the coming weeks but could decrease moderately in the longer term. You decide to implement a long put calendar spread:

• Buy: 1 XYZ put option with a strike price of $50 expiring in 2 months for $4.00 per share ($400 total).
• Sell: 1 XYZ put option with a strike price of $50 expiring in 1 month for $2.00 per share ($200 total).
• Net debit: -$400 + $200 = -$200 (theoretical maximum loss)

Scenario 1: XYZ price at the first expiration (1 month) is $50

• The short-term put expires worthless.
• You keep the $200 premium from the short-term put and still hold the longer-term put, which now has more time value.
• Potential profit: The value of the remaining long-term put, which will depend on the time to expiration and implied volatility.

Scenario 2: XYZ price at the first expiration (1 month) is $40

• The short-term put is ITM and may be assigned.
• You may exercise or sell the longer-term put to offset the shares you just bought in order to sell those shares at $50 and prevent a large $5,000 outlay at the 1-month mark.
• Theoretical profit or loss: This will depend on the price of XYZ at the second expiration and whether you decide to exercise the long-term put or sell it before expiration.

Scenario 3: XYZ price at the first expiration (1 month) is $60

• Both puts are OTM.
• The short-term put expires worthless, but the value of the long-term put has decreased.
• Theoretical loss: The difference between the initial debit and the value of the remaining long-term put.

This example illustrates the potential outcomes of a long put calendar spread.

Short Call Condor

What is a short call condor?

The short call condor is a neutral options strategy that aims to profit when the underlying asset's price moves significantly outside a defined range. It involves selling one OTM call option with a lower strike price, buying one OTM call with a slightly higher strike price, buying another OTM call with an even higher strike price, and finally selling one OTM call with the highest strike price. 

All options have the same expiration date and are on the same underlying asset. This creates a range between the two long calls where the theoretical maximum loss is incurred, while profits are generated if the price moves significantly above or below this range.

When to use it

The short call condor may be traded when you anticipate increased volatility. Meaning you believe the underlying asset's price will experience a large price swing but you are uncertain whether it will be upwards or downwards.

Building the strategy

To construct a short call condor, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a significant price move.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of increased volatility.
3. Select strike prices: Choose four strike prices. The two middle strike prices define your potential maximum loss range, while the outer two strike prices act as "wings" to limit potential losses.
4. Execute the trade:
   • Sell one call option with the lowest strike price.
   • Buy one call option with the lower-middle strike price.
   • Buy one call option with the higher-middle strike price.
   • Sell one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum theoretical profit.
• Profit from increased volatility: The strategy benefits from large price swings outside the defined range.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.
• Defined risk: The theoretical maximum loss is limited by two call spreads when entering the trade.

Cons:

• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Limited profit potential: The maximum profit is limited to the net credit received when initiating the trade.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will experience a large price swing soon but are unsure of the direction. You decide to implement a short call condor:

• Sell: 1 XYZ call option with a strike price of $45 for $5.00 per share ($500 total).
• Buy: 1 XYZ call option with a strike price of $50 for $3.00 per share ($300 total).
• Buy: 1 XYZ call option with a strike price of $55 for $1.50 per share ($150 total).
• Sell: 1 XYZ call option with a strike price of $60 for $0.50 per share ($50 total).
• Net credit: $500 - $300 - $150 + $50 = $100 (theoretical maximum profit)
• Theoretical maximum loss: -$500 (difference between middle strikes) + $100 (net credit) = -$400
• Breakeven points: $45 + $1.0 = $46 and $60 - $1.0 = $59.00

Scenario 1: XYZ price at expiration is $40

• The underlying price is below the lower middle strike.
• All options expire worthless.
• Net profit: $100 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $52

• The underlying price is between the two long calls.
• The $45 call is exercised, forcing you to sell 100 shares of XYZ at $45.
• To cover the assignment, it is reasonable to exercise the $50 call option you bought.
• You purchase the shares for $5,000 and sell them for $4,500, resulting in a $500 loss from this transaction.
• Net loss: -$500 + $100 = - $400 (theoretical maximum loss)

Scenario 3: XYZ price at expiration is $65

• The underlying price is above the highest strike.
• All call options are ITM and you are assigned $45 and $60 short call options, and you may exercise $50 and $55 long call options, ultimately making $0 loss.
• Net profit: $100 (initial net credit = theoretical maximum profit)

This example illustrates the potential outcomes of a short call condor

Long Put Condor

What is a long put condor?

The long put condor is a neutral options strategy that profits the most when the underlying asset's price stays within a defined range. It involves buying one OTM put option with a lower strike price, selling one OTM put with a slightly higher strike price, selling another OTM put with an even higher strike price, and finally buying one OTM put with the highest strike price. 

All options have the same expiration date and are on the same underlying asset. This creates a range between the two short puts where the theoretical maximum profit is achieved.

When to use it

This strategy may be suitable when you expect the underlying asset's price to remain within a specific range and experience minimal fluctuations.

Building the strategy

To construct a long put condor, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience limited price movement.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of price stability.
3. Select strike prices: Choose four strike prices. The two middle strike prices define your profit range, while the outer two strike prices act as "wings" to limit potential losses.
4. Execute the trade:
   • Buy one put option with the lowest strike price.
   • Sell one put option with the lower-middle strike price.
   • Sell one put option with the higher-middle strike price.
   • Buy one put option with the highest strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is limited to the net debit paid when entering the trade.
• Potential for profit within a range: The strategy profits the most when the underlying price stays between the two middle strike prices at expiration.
• Benefits from low volatility: A decrease in implied volatility can increase the value of the spread.

Cons:

• Limited profit potential: The theoretical maximum profit is limited and depends on the difference between the strike prices and the net debit paid.
• Requires price stability: To maximize profit, the underlying price needs to be between the two middle strike prices at expiration.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Loss if the price moves significantly: If the underlying price moves significantly outside the defined range, the spread can lose value.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will stay between $45 and $40 in the next month. You decide to implement a long put condor:

• Buy: 1 XYZ put option with a strike price of $40 for $5.00 per share ($500 total).
• Sell: 1 XYZ put option with a strike price of $45 for $3.00 per share ($300 total).
• Sell: 1 XYZ put option with a strike price of $50 for $1.50 per share ($150 total).
• Buy: 1 XYZ put option with a strike price of $55 for $0.50 per share ($50 total).
• Net debit: -$500 + $300 + $150 - $50 = -$100 (theoretical maximum loss)
• Theoretical maximum profit: $500 (difference between middle strikes) - $100 (net debit) = $400
• Breakeven points: $40 + $1 = $41 and $55 - $1 = $54

Scenario 1: XYZ price at expiration is $43

• The underlying price is between the two short puts.
• Puts with higher strikes, particularly $55, become substantially ITM, and the two short puts ($45, $50) cost you some money.
• Your long $40 put ends up worthless because the final stock price ($43) is still above $40.
• You are likely assigned to buy shares at $45 and $50.
• You may exercise your long put at $55, allowing you to sell at the $43 market price after being assigned, ultimately resulting in a $300 profit in this series of transactions.
• Net profit: $300 - $100 (initial debit) = $200

Scenario 2: XYZ price at expiration is $38

• The underlying price is below the lower middle strike.
• Your two middle strikes ($45 and $50) are short puts ITM. They offset the gains in the long $55 and $40 puts.
• You end up with no net intrinsic value at expiration, leading to the full $100 debit lost.
• Net loss: -$100 (net debit)

Scenario 3: XYZ price at expiration is $52

• Both short puts ($50 and $45) expire worthless, so you owe nothing on those.
• The $40 long put is also worthless.
• You may buy 100 shares of XYZ at the market price, $52, and exercise the long put at $55 to generate the profit of $300.
• Net profit: $300 - $100 = $200

This example illustrates the potential outcomes of a long put condor.

Short Put Condor

What is a short put condor?

The short put condor is a neutral options strategy that aims to profit when the underlying asset's price moves significantly outside a defined range. It involves selling one OTM put option with a lower strike price, buying one OTM put with a slightly higher strike price, buying another OTM put with an even higher strike price, and finally selling one OTM put with the highest strike price.

All options have the same expiration date and are on the same underlying asset. This creates a range between the two long puts where the theoretical maximum loss is incurred, while profits are generated if the price moves significantly above or below this range.

When to use it

It's employed when a trader expects the underlying price to experience a substantial move, but is unsure of the direction (whether it will be upwards or downwards).

Nevertheless, a short put condor typically involves creating an ITM put spread, which heightens the risk of premature assignment. Indeed, traders seldom implement this as an initial position, but rather use it more to fix or adjust their existing trades. If you think the market is going to make big moves, you may want to avoid selling put condors. Hence, you might want to look at buying strategies like straddles, strangles, iron condors, or iron butterflies.

Building the strategy

To construct a short put condor, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a significant price move.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of increased volatility.
3. Select strike prices: Choose four strike prices. The two middle strike prices define your potential maximum loss range, while the outer two strike prices act as "wings" to limit potential losses.
4. Execute the trade:
   • Sell one put option with the lowest strike price.
   • Buy one put option with the lower-middle strike price.
   • Buy one put option with the higher-middle strike price.
   • Sell one put option with the highest strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum potential profit.
• Profit from increased volatility: The strategy benefits from large price swings outside the defined range.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.
• Defined risk: The theoretical maximum loss is limited by two put spreads when entering the trade.

Cons:

• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Limited profit potential: The theoretical maximum profit is limited to the net credit received when initiating the trade.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price moves significantly against you: If the underlying price moves significantly inside the defined range, the spread can result in substantial losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will experience a large price swing soon but are unsure of the direction. You decide to implement a short put condor:

• Sell: 1 XYZ put option with a strike price of $40 for $5.00 per share ($500 total).
• Buy: 1 XYZ put option with a strike price of $45 for $3.00 per share ($300 total).
• Buy: 1 XYZ put option with a strike price of $50 for $1.50 per share ($150 total).
• Sell: 1 XYZ put option with a strike price of $55 for $0.50 per share ($50 total).
• Net credit: $500 - $300 - $150 + $50 = $100 (theoretical maximum profit)
• Theoretical maximum loss: -$500 (difference between middle strikes) + $50 (net credit) = -$400
• Breakeven points: $40 + $1 = $41 and $55 - $1 = $54

Scenario 1: XYZ price at expiration is $38

• All four puts (40, 45, 50, 55) are ITM.
• You may be assigned for the $40 put and the $50 put.
• You exercise $45 and $50 long puts to cover the loss from the assignment.
• Net profit: $9,000 - $9,000 + $100 (initial net credit) = $100

Scenario 2: XYZ price at expiration is $47

• The underlying price is between the two long puts.
• The $40 put you sold and the $45 put you bought are OTM.
• The $50 and $55 put are ITM.
• You may be assigned a short $55 put to buy 100 shares of XYZ and exercise your $50 short put to partially cover the assignment.
• Net loss: $5,000 - $5,500 + $100 (initial credit) = -$400

Scenario 3: XYZ price at expiration is $60

• The underlying price is above the higher middle strike.
• All options expire worthless.
• Net profit: $100 (theoretical maximum profit)

This example illustrates the potential outcomes of a short put condor.

Long Iron Condor

What is a long iron condor?

The long iron condor is a neutral options strategy that profits when the underlying asset's price moves significantly outside a defined range. It is essentially a combination of a call debit spread and put debit spread.

It involves selling one OTM put option with a low strike price, buying one OTM put with a slightly higher strike price, buying one OTM call with a higher strike price, and selling one OTM call with the highest strike price. All options have the same expiration date and are on the same underlying asset. 

This creates a range between the two short options (one put and one call) where the theoretical maximum loss is incurred, while profits may be generated if the price moves significantly above or below this range.

When to use it

The long iron condor may be used when a trader expects a substantial price swing in the underlying, but is unsure of the direction.

Building the strategy

To construct a long iron condor, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a significant price move.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of increased volatility.
3. Select strike prices: Choose four strike prices. The middle two strike prices define your potential maximum loss range, while the outer two strike prices act as "wings" to limit potential losses. Ensure the distance between the put strikes is the same as the distance between the call strikes.
4. Execute the trade:
   • Sell one put option with the lowest strike price.
   • Buy one put option with the lower-middle strike price.
   • Buy one call option with the higher-middle strike price.
   • Sell one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is limited to the net debit paid when entering the trade.
• Profit from increased volatility: The strategy benefits from large price swings outside the defined range.
• Two potential profit zones: You can profit if the price moves significantly upwards or downwards.

Cons:

• Requires significant price move: The underlying price needs to move substantially in either direction to achieve the potential maximum profit.
• Theta decay: The value of the options erodes as time passes, working against you if the price doesn't move significantly.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price stays within the range: If the underlying price remains within the defined range, the spread can result in the potential maximum loss.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will experience a large price swing soon but are unsure of the direction. You decide to implement a long iron condor:

• Sell: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Buy: 1 XYZ put option with a strike price of $50 for $3.50 per share ($350 total).
• Buy: 1XYZ call option with a strike price of $55 for $3.50 per share ($350 total).
• Sell: 1 XYZ call option with a strike price of $60 for $2.00 per share ($200 total).
• Net debit: $200 - $350 - $350 + $200 = - $300
• Theoretical maximum profit: $300 (difference between put strikes or call strikes) - $0 (net debit) = $300
• Breakeven points: $45 + $2 = $47 and $55 + $2 = $57

Scenario 1: XYZ price at expiration is $40

• The underlying price is below the lower middle strike.
• The $45 put is exercised, and you are assigned on the $45 put. Both of the calls expire worthless.
• You then exercise your bought $50 put and sell the share of XYZ at $50, collecting the profit off the difference: $500 ($50 - $45 = $5 per share × 100 shares).
• Net profit: $500 - $200 = $300 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $52

• The underlying price is between the two option spreads.
• All options expire worthless.
• Net loss: -$200 (initial debit)

Scenario 3: XYZ price at expiration is $57

• The underlying price is above the higher middle strike.
• The $45 put, $50 put, and $60 call options are all OTM and expire.
• You may want to exercise the $55 call to obtain 100 shares of XYZ and sell them at the market price of $57 to generate $200 profit.
• Net profit: $200 - $200 (initial debit) = $0

This example illustrates the potential outcomes of a long iron condor.

Short Iron Condor

What is a short iron condor?

A short iron condor is the inverse of the long iron condor. It's a combination of a call credit spread and a put credit spread. It involves buying one OTM put option with a low strike price, selling one OTM put with a slightly higher strike price, selling one OTM call with a higher strike price, and buying one OTM call with the highest strike price. 

All options have the same expiration date and are on the same underlying asset. This creates a range between the two short options (one put and one call) where maximum profit potential is achieved, while losses may be incurred if the price moves significantly above the highest call options (long call) or below the lowest put options (long put).

When to use it

The short iron condor is a neutral options strategy that aims to profit when the underlying asset's price stays within a defined range. It's typically used when a trader expects the underlying price to experience minimal movement or remain relatively stable, essentially betting against volatility.

Building the strategy

To construct a short iron condor, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience limited price movement.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of price stability.
3. Select strike prices: Choose four strike prices. The middle two strike prices define your profit range, while the outer two strike prices act as "wings" to limit potential losses. Ensure the distance between the put strikes is the same as the distance between the call strikes.
4. Execute the trade:
   • Buy one put option with the lowest strike price.
   • Sell one put option with the lower-middle strike price.
   • Sell one call option with the higher-middle strike price.
   • Buy one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum potential profit.
• Profit from price stability: The strategy profits the most when the underlying price stays between the two middle strike prices at expiration.
• Benefits from low volatility: A decrease in implied volatility can increase the value of the spread.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.
• Defined risk: Even if the underlying price moves significantly in either direction, the theoretical maximum loss is limited.

Cons:

• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Limited profit potential: The maximum profit is typically limited to the net credit received when initiating the trade.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will stay between $48 and $52 in the next month. You decide to implement a short iron condor:

• Buy: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Sell: 1 XYZ put option with a strike price of $48 for $3.50 per share ($350 total).
• Sell: 1 XYZ call option with a strike price of $52 for $2.00 per share ($200 total).
• Buy: 1 XYZ call option with a strike price of $55 for $1.00 per share ($100 total).
• Net credit: -$200 + $350 + $200 - $100 = $250
• Theoretical maximum profit: $250 (net credit)
• Theoretical maximum loss: -$300 (width of the bull put spreads or that of the bear call spreads since they are the same) + $250 (net credit) = -$50
• Breakeven points: $48 - $2.5 = $45.5 and $52 + $2.5 = $54.5

Scenario 1: XYZ price at expiration is $40

• The underlying price is below the lower middle strike.
• Both call options expire worthless.
• You may be assigned on the $48 put, and you would exercise the $45 put to sell your acquired shares of stock at $45, eventually resulting in a $300 loss in this series of transactions. 
• Net loss: -$300 + $250 = -$50

Scenario 2: XYZ price at expiration is $51

• The underlying price is between the two short options.
• All options expire worthless.
• Net profit: $250 (theoretical maximum profit = initial net credit)

Scenario 3: XYZ price at expiration is $57

• The underlying price is above the higher middle strike.
• The $52 call is exercised, and you assign the $55 call. Both puts expire worthless.
• You lose $300 from the call spread.
• Net loss: -$300 + $250 = -$50

This example illustrates the potential outcomes of a short iron condor.

Long Call Butterfly

What is a long call butterfly?

The long call butterfly is a neutral options strategy that profits the most when the underlying asset's price stays at a specific level. It usually involves buying one OTM call option with a lower strike price, selling two ATM calls with a middle strike price, and buying one OTM call with a higher strike price.

All options have the same expiration date and are on the same underlying asset. The strike prices are equidistant, creating a narrow range where maximum profit potential is achieved.

When to use it

The long call butterfly is usually traded when you have a very narrow outlook on the future price of the underlying asset and expect minimal price movement.

The purpose of purchasing a call butterfly is to later dispose of it at a higher price, aiming for a gain. To make money, you'll need an underlying stock that moves steadily and horizontally. The optimal scenario is when the underlying stock hovers precisely at or close to the short strike price and stays there until expiration.

Building the strategy

To construct a long call butterfly, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience very little price movement.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of price stability.
3. Select strike prices: Choose three strike prices that are equidistant. The middle strike price should be near the current market price of the underlying asset.
4. Execute the trade:
   • Buy one call option with the lowest strike price.
   • Sell two call options with the middle strike price.
   • Buy one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Defined risk: The potential maximum loss is limited to the net debit paid when entering the trade.
• High potential profit at a specific price: The strategy profits the most when the underlying price is at the middle strike price at expiration.
• Benefits from low volatility: A decrease in implied volatility can increase the value of the spread.

Cons:

• Limited profit potential: The theoretical maximum profit is limited and depends on the difference between the strike prices and the net debit paid.
• Requires price stability at a specific level: To maximize profit, the underlying price needs to be at the middle strike price at expiration.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Loss if the price moves significantly: If the underlying price moves significantly away from the middle strike price, the spread can lose value.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You strongly believe it will stay at $50 in the next month. You decide to implement a long call butterfly:

• Buy: 1 XYZ call option with a strike price of $45 for $7.00 per share ($700 total).
• Sell: 2 XYZ call options with a strike price of $50 for $4.00 per share ($800 total).
• Buy: 1 XYZ call option with a strike price of $55 for $2.00 per share ($200 total).
• Net debit: $700 - $800 - $200 = - $100 (theoretical maximum loss)
• Theoretical maximum profit: $500 (difference between lowest and middle strikes) - $100 (net debit) = $400
• Breakeven points: $45 + $1.00 = $46 and $55 - $1.00 = $54

Scenario 1: XYZ price at expiration is $50

• The underlying price is at the middle strike price.
• Both $50 calls expire worthless. The $55 call also expires worthless.
• You may exercise the $45 call to buy XYZ at $45 and sell it at the market price of $50, making a $500 profit.
• Net profit: $500 - $100 (net debit) = $400 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $53

• The underlying price is above the middle strike price.
• The $55 call expires worthless.
• Both $50 may be assigned, and you need to sell 200 shares of XYZ.
• You can exercise the sold $45 call as well as buying 100 additional 100 shares of XYZ to cover your assignment.
• Net profit: $5000 × 2 - $4500 - $5300 - $100 (net debit) = $100

Scenario 3: XYZ price at expiration is $42

• The underlying price is below the lowest strike price.
• All options expire worthless.
• Net loss: - $100 (theoretical maximum loss)

This example illustrates the potential outcomes of a long call butterfly.

Short Call Butterfly

What is a short call butterfly?

The short call butterfly is a neutral options strategy that aims to profit when the underlying asset's price moves significantly away from a specific level. 

A short call butterfly spread is the opposite of a long call butterfly and usually involves selling one OTM call option with a lower strike price, buying two ATM calls with a middle strike price, and selling one OTM call with a higher strike price. All options have the same expiration date and are on the same underlying asset.

The strike prices are equidistant, creating a narrow range around the middle strike where maximum loss potential is achieved.

When to use it

A short call butterfly is a volatility strategy typically used to possibly generate profit. This strategy is typically used when a trader expects the underlying price to experience a moderate price swing, but is unsure of the direction. It essentially bets on volatility exceeding a certain threshold.

Building the strategy

To construct a short call butterfly, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a moderate price move.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of a price swing.
3. Select strike prices: Choose three strike prices that are equidistant. The middle strike price should be near the current market price of the underlying asset.
4. Execute the trade:
   • Sell one call option with the lowest strike price.
   • Buy two call options with the middle strike price.
   • Sell one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum potential profit.
• Profit from moderate volatility: The strategy profits when the underlying price moves significantly away from the middle strike price.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.
• Defined risk: The theoretical maximum loss is limited by two long calls in the middle when entering the trade. 

Cons:

• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Limited profit potential: The theoretical maximum profit is limited to the net credit received when initiating the trade.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price stays near the middle strike: If the underlying price remains near the middle strike price at expiration, the spread can result in substantial losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will move moderately but are unsure of the direction. You decide to implement a short call butterfly:

• Sell: 1 XYZ call option with a strike price of $45 for $7.00 per share ($700 total).
• Buy: 2 XYZ call options with a strike price of $50 for $4.00 per share ($800 total).
• Sell: 1 XYZ call option with a strike price of $55 for $2.00 per share ($200 total).
• Net credit: $700 - $800 + $200 = $100 (theoretical maximum profit)
• Theoretical maximum loss: -$500 (difference between lowest and middle strikes) + $100 (net credit) = -$400
• Breakeven points: $45 + $1.00 = $46 and $55 - $1.00 = $54

Scenario 1: XYZ price at expiration is $50

• The underlying price is at the middle strike price.
• Both $50 calls and the $55 call expire worthless
• The $45 call is exercised, which requires buying them at the market price of $50.
• You lose $500 from buying at $50 and selling them at $45 call
• Net loss: - $5000 + $4500 + $100 (net credit) = - $400 (theoretical maximum loss)

Scenario 2: XYZ price at expiration is $53

• The underlying price is above the middle strike price.
• The $55 call expires worthless.
• The $45 call is potentially assigned, and you need to buy the share by exercising one of the bought $50 calls, leaving you the $500 loss in this series of transactions. 
• You can also exercise the bought $50 call to obtain the share and sell them at the market price of $53, creating the potential profit of $300
• Net loss: -$5,000 × 2 + $4,500 + $5,300 + $100 (initial credit) = -$100

Scenario 3: XYZ price at expiration is $42

• The underlying price is below the lowest strike price.
• All options expire worthless.
• Net profit: $100 (theoretical maximum profit)

This example illustrates the potential outcomes of a short call butterfly.

Long Put Butterfly

What is a long put butterfly?

The long put butterfly is a neutral options strategy that has the most profit potential when the underlying asset's price stays at a specific level. A long put butterfly spread usually involves buying one OTM put option with a lower strike price, selling two ATM puts with a middle strike price, and buying one OTM put with a higher strike price. 

All options have the same expiration date and are on the same underlying asset. The strike prices are equidistant, creating a narrow range where the theoretical maximum profit is achieved.

When to use it

It's employed when a trader has a very narrow outlook on the future price of the underlying asset and expects minimal price movement, or even better, doesn’t move at all, and implied volatility drops. If this happens, over time the butterfly spread will increase in value.

Building the strategy

To construct a long put butterfly, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience very little price movement.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of price stability.
3. Select strike prices: Choose three strike prices that are equidistant. The middle strike price should be near the current market price of the underlying asset.
4. Execute the trade:
   • Buy one put option with the lowest strike price.
   • Sell two put options with the middle strike price.
   • Buy one put option with the highest strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is limited to the net debit paid when entering the trade.
• High potential profit at a specific price: The strategy profits the most when the underlying price is at the middle strike price at expiration.
• Benefits from low volatility: A decrease in implied volatility can increase the value of the spread.

Cons:

• Limited profit potential: The theoretical maximum profit is limited and depends on the difference between the strike prices and the net debit paid.
• Requires price stability at a specific level: To maximize profit, the underlying price needs to be at the middle strike price at expiration.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Loss if the price moves significantly: If the underlying price moves significantly away from the middle strike price, the spread can lose value.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You strongly believe it will stay at $50 in the next month. You decide to implement a long put butterfly:

• Buy: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Sell: 2 XYZ put options with a strike price of $50 for $4.00 per share ($800 total).
• Buy: 1 XYZ put option with a strike price of $55 for $7.00 per share ($700 total).
• Net debit: -$200 + $800 - $700 = -$100 (theoretical maximum loss)
• Theoretical maximum profit: $500 (difference between middle and highest strikes) - $100 (net debit) = $400
• Breakeven points: $55 - $1.00 = $54 and $45 + $1.00 = $46

Scenario 1: XYZ price at expiration is $50

• The underlying price is at the middle strike price.
• The $55 put is exercised, and both $50 puts expire worthless. The $45 put also expires worthless.
• You buy it at the market price of $50 and exercise the $55 put to sell XYZ at $55, making a $500 profit.
• Net profit: $500 - $100 (net debit) = $400 (theoretical maximum profit)

Scenario 2: XYZ price at expiration is $47

• The underlying price is below the middle strike price.
• Both the $50 puts are likely assigned and you may need to exercise $45 and $55 put options to cover the assignments. 
• Net loss: $10,000 - $10,000 - $100 = -$100

Scenario 3: XYZ price at expiration is $58

• The underlying price is above the highest strike price.
• All options expire worthless.
• Net loss: -$100 (theoretical maximum loss)

This example illustrates the potential outcomes of a long put butterfly.

Short Put Butterfly

What is a short put butterfly?

The short put butterfly is a neutral options strategy that aims to profit when the underlying asset's price moves significantly away from a specific level. Opposite to the long put butterfly, it often involves selling one OTM put option with a lower strike price, buying two ATM puts with a middle strike price, and selling one OTM put with a higher strike price. 

All options have the same expiration date and are on the same underlying asset. The strike prices are equidistant, creating a narrow range around the middle strike where the potential maximum loss is achieved.

When to use it

A short put butterfly is a volatility strategy typically used to generate possible profit. The short put butterfly is typically used when a trader expects the underlying price to experience a moderate price swing, but is unsure of the direction. It essentially expects volatility to exceed a certain threshold.

Building the strategy

To construct a short put butterfly, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a moderate price move.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of a price swing.
3. Select strike prices: Choose three strike prices that are equidistant. The middle strike price should be near the current market price of the underlying asset.
4. Execute the trade:
   • Sell one put option with the lowest strike price.
   • Buy two put options with the middle strike price.
   • Sell one put option with the highest strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum potential profit.
• Profit from moderate volatility: The strategy profits when the underlying price moves significantly away from the middle strike price.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.

Cons:

• Limited profit potential: The theoretical maximum profit is limited and depends on the difference between the strike prices.
• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price stays near the middle strike: If the underlying price remains near the middle strike price at expiration, the spread can result in substantial losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will move moderately but are unsure of the direction. You decide to implement a short put butterfly:

• Sell: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Buy: 2 XYZ put options with a strike price of $50 for $4.00 per share ($800 total).
• Sell: 1 XYZ put option with a strike price of $55 for $7.00 per share ($700 total).
• Net credit: $200 - $800 + $700 = $100 (theoretical maximum profit)
• Theoretical maximum loss: - $500 (difference between middle and highest strikes) + $100 (net credit) = - $400
• Breakeven points: $55 - $1.00 = $54 and $45 + $1.00 = $46

Scenario 1: XYZ price at expiration is $50

• The underlying price is at the middle strike price.
• The $55 put is exercised, and you may exercise one of the $50 puts. The $45 put expires worthless.
• Net loss: $5000 - $5500 + $100 (net credit) = -$400 (theoretical maximum loss)

Scenario 2: XYZ price at expiration is $47

• The underlying price is below the middle strike price.
• The $45 put expires worthless.
• The $55 put may be assigned. You may buy at a market price of $47 and exercise both $50 puts to cover the assignment and reduce the loss.
• You pay $10,200 and make $10,000 from the two puts.
• Net loss: -$5,500 - $4,700 + $5,000 × 2 - $100 (net credit) = -$100

Scenario 3: XYZ price at expiration is $60

• The underlying price is above the highest strike price.
• All options expire worthless.
• Net profit: $100 (theoretical maximum profit)

This example illustrates the potential outcomes of a short put butterfly.

Long Iron Butterfly

What is a long iron butterfly?

The long iron butterfly is a neutral options strategy that expects to profit when the underlying asset's price moves significantly outside a defined range. A long iron butterfly is a combination of a call debit spread and a put debit spread. You may profit if the stock makes a large move beyond the short strikes, as one debit spread gains value while the other loses. This allows you to potentially close the position for a profit before expiration.

It mostly involves selling one OTM put option with a low strike price, buying one ATM put with a middle strike price, buying one ATM call with a middle strike price, and selling one OTM call with the highest strike price. 

The strike prices are equidistant, creating a narrow range around the middle strike where maximum loss potential is achieved.

When to use it

It's typically used when a trader expects a substantial price swing in the underlying, but is unsure of the direction. It essentially bets on volatility exceeding a certain threshold.

Building the strategy

To construct a long iron butterfly, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a significant price move.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of increased volatility.
3. Select strike prices: Choose three strike prices that are equidistant. The middle strike price should be near the current market price of the underlying asset.
4. Execute the trade:
   • Sell one put option with the lowest strike price.
   • Buy one put option with the middle strike price.
   • Buy one call option with the middle strike price.
   • Sell one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Defined risk: The theoretical maximum loss is limited to the net debit paid when entering the trade.
• Profit from increased volatility: The strategy benefits from large price swings outside the defined range.
• Two potential profit zones: You can profit if the price moves significantly upwards or downwards.

Cons:

• Requires significant price move: The underlying price needs to move substantially in either direction to achieve maximum profit potential.
• Theta decay: The value of the options erodes as time passes, working against you if the price doesn't move significantly.
• Complex to manage: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• High IV Increases Cost: If the market expects high volatility, options will be expensive, meaning the stock must move significantly to cover the strategy’s cost.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price stays within the range: If the underlying price remains within the defined range, the spread can result in the theoretical maximum loss.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will experience a large price swing soon but are unsure of the direction. You decide to implement a long iron condor:

• Sell: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Buy: 1 XYZ put option with a strike price of $50 for $3.00 per share ($350 total).
• Buy: 1 XYZ call option with a strike price of $50 for $3.50 per share ($350 total).
• Sell: 1 XYZ call option with a strike price of $55 for $2.00 per share ($200 total).
• Net debit: -$200 + $350 + $300 - $200 = $250
• Theoretical maximum profit: $500 (difference between the lowest (or highest) and middle) - $250 (net debit) = $250
• Breakeven points: $50 + $2.5 = $52.5 and $50 - $2.5 = $47.5

Scenario 1: XYZ price at expiration is $40

• The underlying price is below the lowest strike.
• The calls expire worthless.
• The $45 put is exercised, and you may exercise the $50 long put, resulting in the $500 profit. In another perspective, you make $500 from the put spread.
• Net profit: $500 - $250 = $250

Scenario 2: XYZ price at expiration is $49

• The underlying price is between the the lowest and middle options
• You may buy 100 shares of XYZ and sell them at $50 per share using the bought put option, ultimately making $100 profit.
• Net loss: -$250 + $100 = -$150

Scenario 3: XYZ price at expiration is $57

• The underlying price is above the highest strike.
• The $55 call is exercised, and you may exercise the $50 put to cover the assignment, generating $500 profit from the call spread. The puts expire worthless.
• Net profit: $500 - $250 (net debit) = $250

This example illustrates the potential outcomes of a long iron condor.

Short Iron Butterfly

What is a short iron butterfly?

The short iron butterfly is a neutral options strategy that aims to profit when the underlying asset's price stays within a defined range. It's a combination of a call credit spread and put credit spread.

It typically involves buying one OTM put option with a low strike price, selling one ATM put with a middle strike price, selling one ATM call with a middle strike price, and buying one OTM call with the highest strike price. 

All options have the same expiration date and are on the same underlying asset. The strike prices are equidistant, creating a narrow range where the theoretical maximum profit is achieved.

When to use it

It's employed when a trader expects the underlying price to experience minimal movement or remain relatively stable. It essentially bets against volatility.

Building the strategy

To construct a short iron butterfly, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience limited price movement.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of price stability.
3. Select strike prices: Choose three strike prices that are equidistant. The middle strike price should be near the current market price of the underlying asset.
4. Execute the trade:
   • Buy one put option with the lowest strike price.
   • Sell one put option with the middle strike price.
   • Sell one call option with the middle strike price.
   • Buy one call option with the highest strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum potential profit.
• Profit from price stability: The strategy profits the most when the underlying price stays between the two middle strike prices at expiration.
• Benefits from low volatility: A decrease in implied volatility can increase the value of the spread.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.

Cons:

• Unlimited risk potential: If the underlying price moves significantly against you, the potential loss can be substantial.
• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Limited profit potential: The theoretical maximum profit is limited to the net credit received when initiating the trade.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price moves significantly: If the underlying price moves significantly outside the defined range, the spread can result in substantial losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will stay between $48 and $52 in the next month. You decide to implement a short iron butterfly:

• Buy: 1 XYZ put option with a strike price of $45 for $2.00 per share ($200 total).
• Sell: 1 XYZ put option with a strike price of $50 for $3.00 per share ($350 total).
• Sell: 1 XYZ call option with a strike price of $50 for $3.50 per share ($350 total).
• Buy: 1 XYZ call option with a strike price of $55 for $2.00 per share ($200 total).
• Net credit: -$200 + $300 + $350 - $200 = $250
• Theoretical maximum profit: $250 (net credit)
• Theoretical maximum loss: -$500 (difference between the lowest and middle strike prices) + $250 (net credit) = -$250
• Breakeven points: $50 - $2.5 = $47.5 and $50 + $2.5 = $52.5

Scenario 1: XYZ price at expiration is $40

• The underlying price is below the lowest middle strike.
• The calls expire worthless.
• The $50 put is assigned to you, and you may exercise the bought $50 put to cover the assignment.
• You lose $500 from the put spread.
• Net loss: - $500 + $250 = - $250

Scenario 2: XYZ price at expiration is $51

• The underlying price is between the two call options.
• Depending on the premium, you may be assigned the $50 call option and you possibly exercise the $50 call to cover the assignment. The cost and profit will cancel out in this transaction.
• Net profit: $250 (initial credit)

Scenario 3: XYZ price at expiration is $57

• The underlying price is above the highest strike.
• The puts expire worthless.
• The $52 call is exercised, and you assign the $55 call, ultimately losing $500 from the call spread. 
• Net loss: -$500 + $250 (initial credit) = -$250

This example illustrates the potential outcomes of a short iron butterfly.

Put Front Ratio

What is a put front ratio spread?

The put front ratio spread is a bearish options strategy that profits when the underlying asset's price decreases moderately. A put front ratio spread usually involves buying one ITM put option and selling two further OTM put options with the same expiration date on the same underlying asset. Essentially, this strategy is a combination of a put debit spread and a short put that shares the same short strike price as the debit spread. This is typically done for a net credit, meaning the premium received from selling the two puts exceeds the cost of buying the single put.

When to use it

This strategy may be suitable when you anticipate a moderate price decline in the underlying asset, but not a dramatic one. Additionally, the strategy typically benefits from high implied volatility, as this increases the premiums received for selling the puts.

Building the strategy

To construct a put front ratio spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a moderate price decline.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of a price decline.
3. Select strike prices: Choose two strike prices. The long put strike price should be closer to the current market price (or slightly below), and the short put strike price should be further OTM.
4. Execute the trade:
   • Buy one put option with the higher strike price.
   • Sell two put options with the lower strike price.

Pros, cons, and risks

Pros:

• Net credit received: You receive a net credit when entering the trade, which represents your maximum potential profit.
• Potentially higher probability of profit than short put: The two short puts may increase the probability of profit compared to a simple short put.
• Benefits from theta decay: As time passes, the value of the options tends to decrease, which works in your favor.

Cons:

• Unlimited risk potential: If the underlying price falls significantly below the short puts, the potential loss can be substantial.
• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Limited profit potential: The theoretical maximum profit is limited to the net credit received when initiating the trade.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price moves significantly against you: If the underlying price moves significantly higher, the spread can result in substantial losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $50. You believe it will decrease moderately in the next month. You decide to implement a put front ratio spread:

• Buy: 1 XYZ put option with a strike price of $48 for $2.00 per share ($200 total).
• Sell: 2 XYZ put options with a strike price of $45 for $1.50 per share ($300 total).
• Net credit: $300 - $200 = $100
• Theoretical maximum profit: $300 (the width of the spread) + $100 (initial credit) = $400
• Theoretical maximum loss: unlimited until the stock reaches $0.
• Breakeven point: $45 - $3 = $42

Scenario 1: XYZ price at expiration is $43

• The underlying price is below the short strike.
• The long put is exercised, and you are assigned on both short puts.
• You sell 100 shares of XYZ at $48 and are forced to buy 200 shares at $45. You may also want to sell the remaining shares at the market price of $43. This leaves you a $100 profit.
• Net profit: $100 + $100 (net credit) = $200

Scenario 2: XYZ price at expiration is $46

• The underlying price is below the long strike but above the short strike.
• The long put is exercised, and the short puts expire worthless.
• You sell 100 shares of XYZ at $48 and buy them at the market price of $46, making a $200 profit.
• Net profit: $200 + $100 (net credit) = $300

Scenario 3: XYZ price at expiration is $52

• The underlying price is above the long strike.
• All options expire worthless.
• Net profit: $100 (net credit)

This example illustrates the potential outcomes of a put front ratio spread.

Call Back Ratio

What is a call back ratio spread?

The call back ratio spread is a bullish options strategy that profits when the underlying asset's price increases significantly. It has a higher profit potential than a simple long call, but also carries the risk of losses if the underlying price stays flat or slightly increases.

A call back ratio spread usually involves selling one ITM call option below the current stock price and buying two further OTM call options with the same expiration date on the same underlying asset. Essentially, this strategy is a combination of a call credit spread and a long call that share the same long strike price as the credit spread. This is typically done for a net credit, meaning the premium received from selling the single call exceeds the cost of buying the two calls.

When to use it

This strategy may be suitable when you anticipate a significant price increase in the underlying asset, as you believe its price will increase substantially. Additionally, the strategy typically benefits from high implied volatility, as this increases the potential profit from the long calls.

Building the strategy

To construct a call back ratio spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a significant price increase.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of a price increase.
3. Select strike prices: Choose two strike prices. The short call strike price should be closer to the current market price (or slightly above), and the long call strike price should be further OTM.
4. Execute the trade:
   • Sell one call option with the lower strike price.
   • Buy two call options with the higher strike price.

Pros, cons, and risks

Pros:

• Higher profit potential than long call: The two long calls may increase the profit potential compared to a simple long call if the price moves significantly upwards.
• Benefits from theta decay: As time passes, the value of the short call tends to decrease, which works in your favor.
• Defined maximum loss: The theoretical maximum loss is limited to the net debit paid when entering the trade.

Cons:

• Limited profit if price doesn't move significantly: If the underlying price doesn't increase substantially, the potential profit is limited.
• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions.
• Losses if price stays flat or slightly increases: If the underlying price stays flat or only increases slightly, the spread may result in losses.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.
• Large losses if the price moves significantly against you: If the underlying price moves significantly lower, the spread can result in substantial losses.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $52. You believe it will increase significantly in the next month. You decide to implement a call back ratio spread:

• Sell: 1 XYZ call option with a strike price of $50 for $3.00 per share ($300 total).
• Buy: 2 XYZ call options with a strike price of $55 for $1.00 per share ($200 total).
• Net credit: $300 - $200 = $100
• Theoretical maximum loss: -$500 (width of the spread) + $100 (initial credit) = -$400
• Theoretical maximum profit: Unlimited (theoretically, as the price of the underlying increases)
• Breakeven point: $50 + $1.00 = $51 and $50 + 2 × $5 (difference between short and long options) - $1 (net credit) = $59

Scenario 1: XYZ price at expiration is $58

• The underlying price is above the long strike.
• One of the long calls is exercised, and you are assigned on the short call.
• You buy 100 shares of XYZ at $55 and sell them at $50. This results in a -$500 loss.
• Net loss: -$500 + $100 (net credit) = -$400

Scenario 2: XYZ price at expiration is $54

• The underlying price is below the long strike but above the short strike.
• The short call is exercised, and the long calls expire worthless.
• You are forced to sell 100 shares of XYZ at $50, which you must buy at the market price of $54, resulting in a $400 loss.
• Net loss: -$400 + $100 (net credit) = -$300

Scenario 3: XYZ price at expiration is $48

• The underlying price is below the short strike.
• All options expire worthless.
• Net profit: $100

This example illustrates the potential outcomes of a call back ratio spread.

Put Back Ratio

What is a put back ratio spread?

The put back ratio spread is a bearish options strategy that profits when the underlying asset's price decreases significantly. It has a higher profit potential than a simple long put, but also carries the risk of losses if the underlying price stays flat or decreases slightly.

A put back ratio spread often involves selling one ITM put option above the current stock and buying two OTM put options at a lower price with the same expiration date on the same underlying asset. This is typically done for a net credit, meaning the premium received from selling the single put exceeds the cost of buying the two puts.

When to use it

A put back ratio is commonly used to speculate on the future direction of the underlying stock. This strategy may be suitable when you anticipate:

• Significant price decline: You believe the underlying asset's price will decrease substantially.
• High implied volatility: The strategy benefits from high implied volatility, as this increases the potential profit from the long puts.

Building the strategy

To construct a put back ratio spread, follow these steps:

1. Select an underlying asset: Choose a stock or ETF you believe will experience a significant price decline.
2. Choose an expiration date: Select an expiration date that aligns with your expectation of a price decline.
3. Select strike prices: Choose two strike prices. The short put strike price should be further OTM, and the long put strike price should be closer to the current market price (or slightly below).
4. Execute the trade:
   • Buy two OTM put options with the lower strike price.
   • Sell one ITM put option with the higher strike price.

Pros, cons, and risks

Pros:

• Higher profit potential than long put: The two long puts increase the profit potential compared to a simple long put if the price moves significantly downwards.
• Limited Risk: The maximum loss is limited and occurs if the asset's price remains around the strike price of the sold put at expiration.

Cons:

• Limited profit if price doesn't move significantly: If the underlying price doesn't decrease substantially, the potential profit is limited.
• Requires active management: Managing the spread can be complex, requiring adjustments or closing the position before expiration depending on market conditions. 
• Time Decay: If the anticipated price movement doesn't occur swiftly, time decay can erode the value of the long puts, leading to potential losses.
• Losses if price stays flat or decreases slightly: If the underlying price stays flat or decreases slightly from the initial market price, the spread can result in losses.

Risks:

• Early assignment risk: American-style options can be assigned early, potentially disrupting the strategy.

Example scenario (with P/L calculations)

Let's say XYZ stock is trading at $48. You believe it will decrease significantly in the next month. You decide to implement a put back ratio spread:

• Buy: 2 XYZ put options with a strike price of $46 for $1.00 per share ($100 total).
• Sell: 1 XYZ put option with a strike price of $50 for $3.00 per share ($300 total).
• Net credit: $300 - $200 = $100
• Theoretical maximum loss: -$400 (width of the spread) + $100 (initial credit) = -$300
• Theoretical maximum profit: Unlimited (theoretically, as the price of the underlying decreases)
• Breakeven point: $46 (short put strike price) - $1 (initial credit) = $45 and $46 + 2 × $4 (width of the spread) - $1 (initial credit) = $53

Scenario 1: XYZ price at expiration is $40

• The underlying price is below both the short put and the long puts.
• Both long puts are exercised, and you are assigned on the short put.
• You are forced to buy 100 shares at $50 and may buy another 100 shares at the market price of $40 and then sell 200 shares of XYZ at $46. This results in a $200 profit.
• Net profit: $200 + $100 (net credit) = $300

Scenario 2: XYZ price at expiration is $46

• The underlying price is at the long strike but below the short strike.
• Both long puts expire worthless.
• You may be assigned the short put at $50 and need to sell them at the market price of $46, resulting in a $400 loss.
• Net loss: -$400 + $100 (net credit) = -$300

Scenario 3: XYZ price at expiration is $52

• The underlying price is above both long strikes and the short strike.
• All options expire worthless.
• Net profit: $100

This example illustrates the potential outcomes of a put back ratio spread.

Conclusion

With the ability to build advanced options strategies through our Trading API and dashboard, we are creating flexibility for both algorithmic and manual traders. 

For those interested in manually trading options, the dashboard serves as a centralized hub for trade management, market data access, and more. For developers focused on using Trading API for options trading, Alpaca has a wide variety of SDKs to utilize, such as Alpaca-py or clients like Postman. Learn more about how to trade options through the dashboard or Trading API and sign up for an account.

We also have multiple tutorials on option trading strategies like the options wheel strategy, trading 0dte options, gamma scalping, and delta hedging. Check out all of our options-related content.

If you’re looking for additional technical resources, reference our options documentation for Trading API! It’s the perfect place to start developing and testing your trading algorithms today.

Options trading is not suitable for all investors due to its inherent high risk, which can potentially result in significant losses. Please read Characteristics and Risks of Standardized Options before investing in options.

Past hypothetical backtest results do not guarantee future returns, and actual results may vary from the analysis.

The Paper Trading API is offered by AlpacaDB, Inc. and does not require real money or permit a user to transact in real securities in the market. Providing use of the Paper Trading API is not an offer or solicitation to buy or sell securities, securities derivative or futures products of any kind, or any type of trading or investment advice, recommendation or strategy, given or in any manner endorsed by AlpacaDB, Inc. or any AlpacaDB, Inc. affiliate and the information made available through the Paper Trading API is not an offer or solicitation of any kind in any jurisdiction where AlpacaDB, Inc. or any AlpacaDB, Inc. affiliate (collectively, “Alpaca”) is not authorized to do business.

Please note that this article is for general informational purposes only and is believed to be accurate as of the posting date but may be subject to change. The examples above are for illustrative purposes only.

All investments involve risk, and the past performance of a security, or financial product does not guarantee future results or returns. There is no guarantee that any investment strategy will achieve its objectives. Please note that diversification does not ensure a profit, or protect against loss. There is always the potential of losing money when you invest in securities, or other financial products. Investors should consider their investment objectives and risks carefully before investing.

Securities brokerage services are provided by Alpaca Securities LLC ("Alpaca Securities"), member FINRA/SIPC, a wholly-owned subsidiary of AlpacaDB, Inc. Technology and services are offered by AlpacaDB, Inc.

This is not an offer, solicitation of an offer, or advice to buy or sell securities or open a brokerage account in any jurisdiction where Alpaca Securities are not registered or licensed, as applicable.