Option Strategies
Option Trading Calculations and Analytics
Understanding your potential profits and losses depends on understanding the math
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread:
- premium paid
- The potential loss will always be known before you get into a trade.
The maximum risk is equal to the difference between the strike prices minus the net credit received including commissions.
Example:
If the strike prices is 5.00 (105.00 – 100.00 = 5.00), and the net credit is 1.80 (3.30 – 1.50 = 1.80).
The maximum risk, therefore, is 3.20 (5.00 – 1.80 = 3.20) per share less commissions.
This maximum risk is realized if the stock price is at or above the strike price of the long call at expiration.
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
Vertical ( Bull ) Call Spread:
- Strike price of short call (lower strike) plus net premium received.
- In this example: 100.00 + 1.80 = 101.80
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
Vertical ( Bull ) Call Spread:
- Strike price of short call (lower strike) plus net premium received.
- In this example: 100.00 + 1.80 = 101.80
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
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When do we close Diagonal Spreads?
We generally look for 25-50% of max profit when closing diagonal spreads. Profit occurs when the long option moves further ITM and gains value, and/or if implied volatility increases.
When do we manage Diagonal Spreads?
We manage diagonal spreads when the stock price moves against our spread. In this case, we look to roll down the short option closer to the breakeven price, so that we can collect more premium and reduce our overall risk.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread:
- premium paid
- The potential loss will always be known before you get into a trade.
The maximum risk is equal to the difference between the strike prices minus the net credit received including commissions.
Example:
If the strike prices is 5.00 (105.00 – 100.00 = 5.00), and the net credit is 1.80 (3.30 – 1.50 = 1.80).
The maximum risk, therefore, is 3.20 (5.00 – 1.80 = 3.20) per share less commissions.
This maximum risk is realized if the stock price is at or above the strike price of the long call at expiration.
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
Vertical ( Bull ) Call Spread:
- Strike price of short call (lower strike) plus net premium received.
- In this example: 100.00 + 1.80 = 101.80
Vertical ( Bear ) Put Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless.
Vertical ( Bull ) Call Spread
- Strike Width – Premium Paid
- The difference between the strike prices minus the premium paid
- This profit is realized if the stock price is at or below the strike price of the short call (lower strike) at expiration and both calls expire worthless
Toggle Content
When do we close Diagonal Spreads?
We generally look for 25-50% of max profit when closing diagonal spreads. Profit occurs when the long option moves further ITM and gains value, and/or if implied volatility increases.
When do we manage Diagonal Spreads?
We manage diagonal spreads when the stock price moves against our spread. In this case, we look to roll down the short option closer to the breakeven price, so that we can collect more premium and reduce our overall risk.
Bull Credit Spreads
Just like the name indicates this is a bullish strategy. So you should have somewhat of a bullish outlook when trading a Bull Credit Spread. But as you’ll see in the profit and loss section/diagram the price can also stay the same or even move a little against you. So you can also just be very slightly bullish. Depending on how far you go OTM the price can even move down a lot while you still make money. This defined risk strategy is often used for high probability options selling.
Vertical Credit Spreads are probably the most used option trading strategy out there (especially for high probability options trading). The strategy is very simple to do and only requires a long and a short option contract at different strikes. The Premium received is higher than the amount paid for the long legs, therefore resulting in a net credit. In this article, you will learn everything you need to know about credit spreads.
If you aren’t familiar with options spreads in general, make sure to check out my options spreads article first.
A Bull Put Credit Spread is both limited risk and limited profit. There is a set maximum loss and profit defined before entry. The max loss is bigger than the max profit. Maximum profit is achieved as long as the price stays above the strike of the short position. Maximum loss happens when the price is below the long strike. The long position acts as a hedge and makes this a defined risk trade.
Maximum Profit: Premium received – Commissions
Ex. $20 Premium – $3 = $17 (max profit)
Maximum Loss: Width of Strikes * 100 – Premium received + Commissions
Ex. (Strike 50 and 52) => $2 Width * 100 – $20 Premium + $3 Commissions = $183 (max loss)
(a normal option contract controls 100 shares, therefore *100)
Bull Put Credit Spreads profits from a drop in Implied Volatility. This means it is best to use this strategy when IV is high (IV rank over 50) because you then have a higher chance of making money.
Time Decay or Theta works in favor of this strategy and is therefore positive. The more time goes by, the more value the sold option contract loses which is good for this strategy. The closer to expiration, the more time decay there is daily.
Buy 1 OTM Put
Sell 1 OTM Put (higher strike)
This should result in a credit (You get paid to open)
Bear Call Credit Spreads
A Bear Call Credit Spread is best used for bearish or almost neutral conditions. It gives the holder a cushion for the price to move. The price, therefore, has quite a lot of room to move in where this strategy still is profitable. This defined risk strategy is often used for high probability options selling.
Vertical Credit Spreads are probably the most used option trading strategy out there (especially for high probability options trading). The strategy is very simple to do and only requires a long and a short option contract at different strikes. The Premium received is higher than the amount paid for the long legs, therefore resulting in a net credit. In this article, you will learn everything you need to know about credit spreads.
If you aren’t familiar with options spreads in general, make sure to check out my options spreads article first.
Profit and Loss:
Just like Bull Put Credit Spreads the Bear Call Credit Spread also is a defined risk and defined profit strategy. The maximum profit is reached as long as the price of the underlying stays lower than the strike of the short position. The maximum loss occurs when the price is higher than the long strike. The max loss is bigger than the max profit. The long contract acts as a hedge to make the risk of this strategy limited.
Maximum Profit: Premium received – Commissions
Ex. $20 Premium – $3 = $17 (max profit)
Maximum Loss: Width of Strikes * 100 – Premium received + Commissions
Ex. (Strike 50 and 52) => $2 Width * 100 – $20 Premium + $3 Commissions = $183 (max loss)
(a normal option contract controls 100 shares, therefore *100)
A Bear Call Credit Spread also profits from a drop in Implied Volatility and therefore also should be sold when there is high IV (IV rank over 50). This will increase the chances of winning with this strategy.
Time decay works positively for this setup. Every day the value of the sold option loses some of its extrinsic value and therefore increases your chances of keeping the full premium.
Sell 1 OTM Call
Buy 1 OTM Call (higher strike)
This should result in a credit (You get paid to open)
Credit Spreads are a very good, easy and versatile option strategy. In fact, they are my favorite and most used strategy up to this point. If they are used correctly, they can be very profitable. Credit spreads are one of the best strategies for high probability trading. I would recommend trading credit spreads only with OTM strikes and with a rather high probability of profit. If this is done, the price will have space to move in. The further the strikes are OTM, the higher the probability of profit becomes. Additionally, the max profit decreases and the max loss increases. Too far OTM strikes will result in very small credits and very high max losses. Therefore these should be avoided.
Bull Credit Spreads
As the name implies this is a bearish strategy and therefore your directional assumption should be bearish as well. The further you go OTM with this strategy the more bearish you should be.
The debit spread strategy is relative popular, easy and common for directional option trading. This defined risk vertical spread strategy is very similar to credit spreads. Differences are the risk profile and the more directional behavior of this spread. There are multiple different ways to set up debit spreads. I will be presenting the two most common ones.
This can be a very profitable strategy. A Bull Call Debit Spread is a limited risk and limited profit strategy. The max profit is usually much higher than the max loss for debit spreads. Max profit is achieved when the price of the underlying is anywhere above the short strike. Max loss on the other hand occurs when the price is below the long strike. The break-even point is somewhere in between these strikes.
Maximum Profit: Strike of Short Call – Strike of Long Call (Width of Strikes) – Premium Paid – Commissions
Ex. 53 – 50 = 3 (3$ width of strikes) => 3$ *100 – 50$ (Premium Paid) – 5$ (Commission) = 245$ (max profit)
(a normal option contract controls 100 shares, therefore *100)
Maximum Loss: Premium Paid + Commissions
Ex. 50$ (Premium Paid) + 5$ (Commission) = 55$ (max loss)
A Bull Call Debit Spread profits from a rise in implied volatility. This means it is best to use this strategy when IV is rather low (below IV rank 50).
Time Decay or the option Greek Theta works against this position and is therefore negative. Every day the long option loses some of its extrinsic value. The amount of value lost every day increases the closer you get to expiration.
Sell 1 Put
Buy 1 Put (higher strike)
This should result in a debit (Pay to open)
A Bull Call Debit Spread profits from a rise in implied volatility. This means it is best to use this strategy when IV is rather low (below IV rank 50).
Time Decay or the option Greek Theta works against this position and is therefore negative. Every day the long option loses some of its extrinsic value. The amount of value lost every day increases the closer you get to expiration.
Bull Call Debit Spreads
The debit spread strategy is relative popular, easy and common for directional option trading. This defined risk vertical spread strategy is very similar to credit spreads. Differences are the risk profile and the more directional behavior of this spread. There are multiple different ways to set up debit spreads. I will be presenting the two most common ones.
When trading a Bull Call Debit Spread you obviously should have a bullish assumption. How bullish you should be depends on how far you go OTM. If you stay very close to the current price of the security, you can just be slightly bullish.
This can be a very profitable strategy. A Bull Call Debit Spread is a limited risk and limited profit strategy. The max profit is usually much higher than the max loss for debit spreads. Max profit is achieved when the price of the underlying is anywhere above the short strike. Max loss on the other hand occurs when the price is below the long strike. The break-even point is somewhere in between these strikes.
Maximum Profit: Strike of Short Call – Strike of Long Call (Width of Strikes) – Premium Paid – Commissions
Ex. 53 – 50 = 3 (3$ width of strikes) => 3$ *100 – 50$ (Premium Paid) – 5$ (Commission) = 245$ (max profit)
(a normal option contract controls 100 shares, therefore *100)
Maximum Loss: Premium Paid + Commissions
Ex. 50$ (Premium Paid) + 5$ (Commission) = 55$ (max loss)
A Bull Call Debit Spread profits from a rise in implied volatility. This means it is best to use this strategy when IV is rather low (below IV rank 50).
Time Decay or the option Greek Theta works against this position and is therefore negative. Every day the long option loses some of its extrinsic value. The amount of value lost every day increases the closer you get to expiration.
Buy 1 Call
Sell 1 Call (higher strike)
This should result in a Debit (Pay to open)
Bear Put Debit Spreads
As the name implies this is a bearish strategy and therefore your directional assumption should be bearish as well. The further you go OTM with this strategy the more bearish you should be.
When trading a Bull Call Debit Spread you obviously should have a bullish assumption. How bullish you should be depends on how far you go OTM. If you stay very close to the current price of the security, you can just be slightly bullish.
A Bear Put Debit Spread is a risk defined and limited profit strategy. The max profit achievable is greater than the max loss. The maximum profit is achieved when the price of the underlying is below the short option strike. The max loss happens when the price is above the long strike. The break-even point is between these two strikes.
Maximum Profit: Strike of Long Put – Strike of Short Put – Premium Paid – Commissions
Ex. 50 – 48 = 2 (2$ width of strikes) => 2$ *100 – 40$ (Premium Paid) – 5$ (Commission) = 155$ (max profit)
(a normal option contract controls 100 shares, therefore *100)
Maximum Loss: Premium Paid + Commissions
Ex. 40$ (Premium Paid) + 5$ (Commission) = 45$ (max loss)
Just as a Bull Call Debit Spread the Bear Put Debit Spread also profits from a rise in implied volatility and therefore should be used in times of low IV (IV rank under 50). Doing this will increase your chances of winning.
The Time Decay or Theta is negative and doesn’t work in the favor of this strategy. The long option will lose some extrinsic value as time passes. It loses value at a faster rate the closer you get to expiration.
Sell 1 Put
Buy 1 Put (higher strike)
This should result in a debit (Pay to open)
Calendar Spreads
The calendar spread options strategy is very widely used and has its special kind of purpose. It is often used to balance out portfolios because with it, it is possible to target specific strike prices. Here you will get a calendar spread explained:
The beauty of the calendar spread trading strategy is that it can be used for almost every direction. For a neutral, bullish or bearish market outlook. With calendar spreads you try to target one specific strike which can be as far OTM or close to the market as you desire. This is also the reason why this strategy is so great to balance out portfolios.
A Bear Put Debit Spread is a risk defined and limited profit strategy. The max profit achievable is greater than the max loss. The maximum profit is achieved when the price of the underlying is below the short option strike. The max loss happens when the price is above the long strike. The break-even point is between these two strikes.
Maximum Profit: Strike of Long Put – Strike of Short Put – Premium Paid – Commissions
Ex. 50 – 48 = 2 (2$ width of strikes) => 2$ *100 – 40$ (Premium Paid) – 5$ (Commission) = 155$ (max profit)
(a normal option contract controls 100 shares, therefore *100)
Maximum Loss: Premium Paid + Commissions
Ex. 40$ (Premium Paid) + 5$ (Commission) = 45$ (max loss)
This strategy can profit quite a lot from a rise in volatility because the back month long option will gain in value when IV rises. Therefore, the calendar spread option strategy logically should be traded in times of rather low volatility (under IV rank 50).
Until the expiration of the first contract time decay or Theta works in favor of this strategy. This is because the sold front month option loses value faster than the further away long option. This is what the whole strategy is based on. But after the expiration of the short option a calendar spread will turn into a long call or put (depending on what you used) and a normal long option loses value from time decay. So Theta then turns negative.
A calendar spread is a defined risk strategy with a limited upside as well (until expiration of the shorter term option. If that expires worthless you are left with a long call or put with unlimited upside and defined risk). The maximum profit of the original strategy is rarely hit perfectly because to reach max profit the underlying price has to be at one specific strike. It is very difficult to predict this specific price and therefore max profit isn’t reached too often. But this strategy still profits when the price is near the targeted strike or if implied volatility rises enough. Max loss occurs when the price is far enough away from the targeted strike. The main profit of this strategy comes from the different rate of time decay of the two options. The short option is nearer to expiration and therefore ‘gains’ (sold option loses) value faster than the long further away option loses value.
Long Butterfly Spreads
Butterflies are neutral, cheap, low probability option strategies with relatively high potential payouts if used correctly. They have similar payoffs as calendar spreads but work quite differently. There are different ways to set up butterfly spreads. I will cover the most common ones here.
When trading long butterfly spreads you should definitely have a neutral/range bound market outlook. You should expect that the price of the underlying asset only will move little. But different from Iron Condors, Strangles and Straddles butterfly spreads are much tighter and don’t allow the price to move that much. Therefore, long butterfly spreads are not suited for high probability trading. You can either set up a butterfly spread with calls or puts:
A Bear Put Debit Spread is a risk defined and limited profit strategy. The max profit achievable is greater than the max loss. The maximum profit is achieved when the price of the underlying is below the short option strike. The max loss happens when the price is above the long strike. The break-even point is between these two strikes.
Maximum Profit: Strike of Long Put – Strike of Short Put – Premium Paid – Commissions
Ex. 50 – 48 = 2 (2$ width of strikes) => 2$ *100 – 40$ (Premium Paid) – 5$ (Commission) = 155$ (max profit)
(a normal option contract controls 100 shares, therefore *100)
Maximum Loss: Premium Paid + Commissions
Ex. 40$ (Premium Paid) + 5$ (Commission) = 45$ (max loss)
Time decay or the option Greek Theta works in favor of long butterfly spreads. Even though you have two long positions, the two short options still profit more from the time decay than the long positions lose from it. Time decay is highest in the last weeks before expiration.
Normally butterfly spreads profit from a drop in implied volatility (IV). This means that it is best to enter a butterfly spread in a high IV environment (IV rank over 50). But if the price moves a certain way after entry a butterfly spread can actually also profit from a rise in IV. So it depends on where the underlying price is. But I would always recommend that you enter this spread in times of high IV. But in general, IV won’t have a too large impact on butterfly spreads.
T
- Buy 1 ITM Call
- Buy 1 OTM Call
- Sell 2 ATM Calls
or
- Buy 1 OTM Put
- Buy 1 ITM Put
- Sell 2 ATM Puts
This should result in a debit (Pay to open)
Short Butterfly Spreads
A short butterfly strategy is a rather uncommon strategy, because of its low probability nature and low-profit potential. I personally would not recommend a short butterfly spread. I would much rather recommend using other spreads like long straddles or strangles. These much more commonly used strategies work in a similar way but have unlimited profit potential.
If you choose to trade a short butterfly spread, you should expect a big move in the near future. The price won’t have to move as far as it would have to in some straddle strategies, but it still has to move a little. Such a small move isn’t unlikely and therefore short butterfly spreads can be used for high probability option strategies. If the underlying asset makes an even bigger move than you expect, you won’t make any more money, because of the limited profit potential of this strategy.
A short butterfly spread is a defined risk and defined profit strategy, just like you can see on the payoff diagram. The maximum profit is reached as soon as the price of the underlying asset moves a little further than one of the strikes of the short options. The maximum loss occurs when the price of the underlying is exactly at the strike of the two long positions. Max loss won’t occur too often because it only occurs on this very small spot.
Maximum Profit: Total Premium received – Commissions
Ex. 20$ Premium – 3$ = 17$ (max profit)
Maximum Loss: Strike of Short Option – Strike of Long Option (Width of Strikes) (*100) – Total Premium received + Commissions
Ex. (Strike 50 and 52) => 2$ Width * 100 – 20$ Premium + 3$ Commissions = 183$ (max loss)
(a normal option contract controls 100 shares, therefore *100)
Time decay does not work in favor of a short butterfly spread. This is because it has a negative impact on the long options, which are the most valuable in this strategy. Time decay or the option Greek Theta will increase the closer you get to expiration.
A short butterfly spread usually profits from a rise in implied volatility (IV). Therefore, this strategy is best used in times of low IV (IV rank under 50). But just as said before, IV won’t have a too large impact on butterfly spreads.
- Sell 1 ITM Call
- Sell 1 OTM Call
- Buy 2 ATM Calls
or
- Sell 1 OTM Put
- Sell 1 ITM Put
- Buy 2 ATM Puts
This should result in a credit (You get paid to open)
Variations
There are a few other butterfly spread variations, like the iron butterfly option strategy. An iron butterfly is very similar compared to a normal butterfly spread. The payoff is exactly the same, but the setup is a little different. The setup reminds of a very narrow iron condor:
Setup
Long Iron Butterfly:
Sell 1 OTM Call
Buy 1 ATM Call
Buy 1 ATM Put
Sell 1 OTM Put
This should result in a debit (Pay to open)
Short Iron Butterfly:
Buy 1 OTM Call
Sell 1 ATM Call
Sell 1 ATM Put
Buy 1 OTM Put
This should result in a credit (You get paid to open)
Iron butterflies work almost the same way as normal butterfly spreads. But a few aspects are a little different. For example, the max profit and max loss are calculated a little differently. Leave a comment if you want me to go more in-depth on iron butterflies.
Otherwise, there are even more variations of butterfly spreads, like the broken wing butterfly. Broken wing butterfly spreads work rather different than normal butterflies do and that’s why I covered them in THIS ARTICLE.
Short Iron Condors
Iron Condors are defined risk strategies with two break-even-points. They are one of the most commonly used option strategies.
When trading Short Iron Condors you should have a neutral/range bound market assumption. This means you hope for relatively small or no move at all in the underlying. Short Iron Condors can be very slim (just a few strikes apart) or very wide (far apart strikes) depending on your assumption. Many people including me use Short Iron Condors with two high probability strikes as a high probability strategy.
As you can see on the payoff-diagram a Short Iron Condor isn’t just a defined risk trade, but also a defined profit trade. The maximum profit is achieved when the underlying price is somewhere between the two short strikes. The maximum loss occurs when the price is anywhere outside of the two long strikes. It doesn’t matter if the price is $10 or $100 outside of the profitable range because the two long options on both sides act as a hedge. The maximum loss is higher than the maximum profit.
Maximum Profit: Premium received – Commissions
Ex. $20 Premium – $3 Commission = $17 (max profit)
Maximum Loss: Width of Call Strikes * 100 – Premium Received + Commissions Paid
Ex. (Call Strikes: 50 and 52) => $2 Width * 100 – $20 Premium + $3 Commissions = $183 (max loss)
(a normal option contract controls 100 shares, therefore *100)
A Short Iron Condor profits from a drop in Implied Volatility (IV), because the options sold then lose value. Therefore, it is best to use this strategy in times of high IV (IV rank over 50).
Time Decay also works in favor of this strategy. The more time goes by the more the sold options lose in their extrinsic value. The time decay for each day increases the closer you get to expiration.
- Buy 1 OTM Put
- Sell 1 OTM Put (higher strike)
- Sell 1 OTM Call
- Buy 1 OTM Call (higher strike)
This should result in a credit (You get paid to open).
Short Strangles
Strangles are another quite popular strategy suitable for bigger accounts. They are the either undefined risk or undefined profit correspondent to an iron condor and are used in similar ways. But they have a greater profit potential. There are two types of strangles which I will present to you below:
When trading a short strangle, you should have a neutral/range bound market assumption. By moving the short strangle up or down you can make it neutral with slight directional tilt. But generally a short strangle is a neutral strategy. Short strangles can be rather tight or very wide depending on which strikes you choose. If you decide to choose further out strikes, you will give up some of your profit potential but will get a higher chance of making money. This is also the reason why this is one of the best undefined risk strategies for high probability trading.
As seen on the payoff diagram a short strangle has unlimited risk and limited profit. The only differences between a short strangle and a short iron condor are the two long legs added for protection on each side of an iron condor. These are missing on a strangle and therefore it has unlimited risk, but also a higher profit potential. The maximum profit is achieved when the price of the underlying security stays between the two strikes. The break-even points are a little further out. The tighter a short strangle is the higher the profit potential becomes. But with that the probability of winning sinks.
Maximum Profit: Premium received – Commissions
Maximum Loss: N/A (unlimited)
This short strategy profits from a drop in implied volatility and should, therefore, be used in times of high IV (IV rank over 50). This will increase the premium taken in and increase the chances of making money.
Since this is a short strategy Theta (time decay) is positive and works in favor of it. This means that the sold options lose some of their extrinsic value over time and thus increases the chances of winning over time.
- Sell 1 OTM Put
- Sell 1 OTM Call
This should result in a credit (You get paid to open)
Notes
Long Strangles
Strangles are another quite popular strategy suitable for bigger accounts. They are the either undefined risk or undefined profit correspondent to an iron condor and are used in similar ways. But they have a greater profit potential. There are two types of strangles which I will present to you below:
A long strangle is very similar to a long iron condor. This means the market assumption should be more or less the same when trading one of these strategies. You should be expecting some form of bigger move, but unsure in which direction, in the near future when trading these strategies. The further you go OTM with this strategy the bigger the expected move has to be.
This is a defined risk, but unlimited profit strategy. The maximum loss occurs when the price of the underlying asset either stays the same or doesn’t move enough. The further you go OTM with the strikes the lower your max loss becomes. But this also reduces the chances of making money since the price of the underlying has to move even further. The profit rises the more the price of the underlying surpasses a break-even point.
Maximum Profit: N/A (unlimited)
Maximum Loss: Premium paid to open + Commissions
A long strangle is most suitable for a low implied volatility environment (IV rank under 50) since it profits from a rise in IV.
Theta (time decay) is negative for this strategy hence time decay works against a holder of it. The long options lose a little of their extrinsic value over time. The more time goes by, the bigger each loss from time decay becomes.
- Buy 1 OTM Call
Buy 1 OTM Put
This should result in a debit (Pay to open)
Notes
Short Straddles
Options straddle strategies are very popular and profitable. They are very similar to strangles, another neutral strategy. There are two different types of straddles, a long straddle, and a short straddle – both for their own purposes. It is extremely easy to set up and trade this strategy.
A short straddle is a neutral/range-bound strategy. It is used when you assume that the price of an underlying will stay between two points until expiration. You can move these two points a little more to the upside/downside to create a slightly directional straddle. But in general, this strategy should still be traded with a range-bound market assumption. This is another quite popular strategy for neutral high probability trading because the break-even points can be quite far apart. Theoretically, you could target OTM strikes and create a very directional short straddle, but I really don’t recommend this.
This is an undefined risk and defined profit strategy (just as seen on the payoff-diagram above). This means there is no set limit to how much money you could lose, but there is a limit to how much you can make. But because the Premium taken in is quite high, the profit potential is rather good and the break-even points are fairly far apart. Maximum Profit is achieved when the price of the underlying is exactly at the strike of the two short options. With this strategy, you first begin to lose money when the underlying price moves very far away from your targeted strike.
Maximum Profit: Premium received – Commissions
Maximum Loss: N/A (unlimited)
A short straddle profits from a drop in implied volatility and should, therefore, be traded in high IV environments (IV rank over 50). Doing this will increase the premium taken in and the chances of winning.
Time Decay or Theta works in favor of this strategy. This means every day the two sold options lose a small part of their value which will increase your probability of success. The amount of time decay increases the closer you get to expiration.
Sell 1 Put
Sell 1 Call (at same strike price)
To make a straddle as neutral as possible you should use ATM strikes.
This should result in a credit (You get paid to open).
Notes
Long Straddles
Options straddle strategies are very popular and profitable. They are very similar to strangles, another neutral strategy. There are two different types of straddles, a long straddle, and a short straddle – both for their own purposes. It is extremely easy to set up and trade this strategy.
The long straddle is a very easy neutral/price indifferent options strategy. This means that you assume that the price of an underlying will make a big move in the near future, but you don’t know in which direction. The long straddle will profit from a big move in either direction. This can be used for bigger events/announcements where a big move isn’t unlikely.
Just as seen on the payoff-diagram a long straddle is an unlimited profit and limited risk strategy. The max loss normally still can be relatively high. But the maximum loss occurs very rarely, because to achieve max loss the price of the underlying has to be precisely at the strike price of the long options. That this happens is rather unlikely. But if the price doesn’t move far enough, you still will lose money. As soon as the price of the underlying security moves far enough, you begin to make money. The further it moves the more money you make.
Maximum Profit: N/A (unlimited)
Maximum Loss: Premium Paid + Commissions
A long straddle profits from a rise in implied volatility and thus should be used in a low IV environment (IV rank under 50). This will make this strategy cheaper to enter and will increase the chances of winning.
Theta or time decay does not work in favor of a long straddle. The long options bought in this strategy constantly lose some of their extrinsic value. The closer to expiration the higher losses through time decay become.
Buy 1 Put
Buy 1 Call (at the same strike)
Usually, an ATM strike is used
This should result in a debit (You pay to open)
Notes
Common Strategies
Short and Long Calls
Short and Long Puts
Credit Spreads
Debit Spreads
Long Strangles
Long Straddles
Iron Condor
Short Straddles
Short Strangles
Iron Butterfly
Iron Fly
Diagonal Spreads
Diagonal Calendar Spreads
Box Spreads
Bullish Strategies
Bearish Strategies
Neutral Strategies
Trade Adjustments
Keys to understanding options
Indicators
Building Blocks
Greeks
Implied Volatility
The Mark
Trade Management
Common Indicators
Resistance
Support
MACD
RSI
Volume
Moving Average
What you need to know on every trade
Market direction
Maximum Profit
Maximum Loss
Break Even
The Mark
Implied Volatility