Option Strategies

From Single Options to Strategies

Real options trading is almost never about buying or selling a single option in isolation. Instead, traders combine options (and sometimes the underlying stock) into strategies — multi-leg structures that target specific payoff profiles, risk/reward ratios, and Greek exposures. Understanding why each strategy exists, and when to use it, is the difference between speculation and precision.

Every strategy can be analyzed in two dimensions: its payoff at expiration (a function of the stock price) and its Greeks profile (how it responds to moves in S, σ, and t right now). Both dimensions matter. The payoff diagram tells you where you make money at expiration; the Greeks tell you how you feel getting there.

Covered Call: Selling Upside for Income

The covered call is the most common options strategy used by equity investors. You own the underlying stock and sell a call option against it:

Long 100 shares + Short 1 call (K = strike above current price)

Payoff at expiration: If S_T < K: you keep the stock (worth S_T) plus the call premium. If S_T > K: you keep the premium plus K (you're forced to sell at K, capping your upside).

Why use it? You're long the stock anyway and don't expect a large move. The call premium provides income and reduces your effective cost basis. The risk: if the stock surges past K, you miss the extra gains. The trade is explicitly giving up upside for current income.

Greek profile: Net delta ≈ (1 − Δ_call) per share. Short vega (you want volatility to drop — it makes the short call cheaper to close). Positive theta (you earn time decay on the short call).

Vertical Spreads: Defined Risk, Defined Reward

A vertical spread buys one option and sells another option at a different strike with the same expiry and underlying. The spread limits both risk and reward, making it ideal when you have a directional view but want to reduce the cost and avoid unlimited naked short risk.

Bull Call Spread: Buy a call at K₁, sell a call at K₂ > K₁. Both same expiry.

• Max profit: (K₂ − K₁) − net premium paid. Achieved when S_T ≥ K₂.
• Max loss: net premium paid. Achieved when S_T ≤ K₁.
• Breakeven: K₁ + net premium paid.

You pay less than buying a naked call (the short call subsidizes the long), but you cap your upside at K₂. Use when you're moderately bullish — you don't need a home run, just a move above K₂.

Bear Put Spread: Buy a put at K₂, sell a put at K₁ < K₂. Both same expiry.

• Max profit: (K₂ − K₁) − net premium paid. Achieved when S_T ≤ K₁.
• Max loss: net premium paid. Achieved when S_T ≥ K₂.

Use when you're moderately bearish. The short lower-strike put subsidizes the higher-strike long put.

Straddle: Trading Pure Volatility

A long straddle buys a call and a put at the same strike and expiry:

Long call (K, T) + Long put (K, T) — same strike and expiry

The straddle profits from large moves in either direction. If the stock shoots up, the call profits. If it crashes, the put profits. The only scenario that hurts is the stock staying near K — in which case both options expire near-worthless and you lose the combined premium.

Break-even points: K ± total premium paid. A straddle with K = 100 and total premium of $8 has break-evens at $92 and $108.

Greek profile: Delta ≈ 0 at initiation (the call's positive delta and the put's negative delta cancel). Long gamma (profits from any large move). Short theta (pays time decay on two options). Long vega (profits when IV rises — the straddle is a bet on IV being too low right now).

Traders buy straddles before events (earnings, Fed decisions) when they expect a large move but are unsure of direction. They sell straddles when they believe IV is too high and the stock will stay quiet.

Strangle: A Cheaper Straddle

A strangle is like a straddle but uses OTM strikes instead of ATM:

Long OTM put (K₁ < S) + Long OTM call (K₂ > S)

Because both options are OTM, the premium paid is lower than a straddle. But the stock must move even further to reach the break-even points. Strangles are cheaper but require larger moves to profit.

Iron Condor: Selling the Tails

An iron condor combines a bull put spread and a bear call spread:

Short put at K₂ + Long put at K₁ (K₁ < K₂) + Short call at K₃ + Long call at K₄ (K₃ < K₄)

where K₁ < K₂ < S < K₃ < K₄. The position collects premium and profits as long as the stock stays between K₂ and K₃ at expiration — the "condor body." The long options at K₁ and K₄ cap losses if the stock makes a large move.

Max profit: Net premium collected. Achieved when K₂ ≤ S_T ≤ K₃.

Max loss: Width of one spread − net premium. Achieved when S_T ≤ K₁ or S_T ≥ K₄.

Greek profile: Short vega (profits from IV decrease), positive theta (time decay works for you). Net delta ≈ 0 if structured symmetrically. The iron condor is a pure volatility-selling strategy — you're betting the stock won't make a large move before expiry.

Choosing the Right Strategy

Each strategy expresses a specific market view:

• Moderately bullish: Bull call spread
• Moderately bearish: Bear put spread
• Big move, unclear direction: Straddle or strangle (long)
• Stock stays flat, IV too high: Short straddle, strangle, or iron condor
• Own stock, want income: Covered call

The Greek profile should match your time horizon and risk tolerance. Buying straddles bleeds theta daily — you need your event to happen quickly. Selling iron condors collects theta slowly — you benefit from the passage of time and punish by tail moves. Understanding this alignment is what separates systematic options trading from gambling.