F& O Strategies

Bullish Strategies Call Buying Bull Call Spread The Collar Call Backspread Bull Calendar Spread Covered Calls Naked Puts Covered Straddle Bearish Strategies Put Buying Bear Put Spread Put Backspread Covered Puts Naked Calls Neutral Strategies Ratio Spread The Straddle The Strangle The Butterfly The Condor The Iron Butterfly The Iron Condor Calendar Straddle Other Strategies Calendar Spread Synthetic Positions Options Arbitrage Options Brokerages optionsXpress thinkOrSwim

Bullish Strategies Call Buying The long call is the simplest strategy in options trading and involves the purchase of a call option. The options trader employing the long call strategy believes that the price of the underlying stock will go up beyond a certain price within a certain period of time.

Bull Call Spread A bull call spread is a bullish strategy in options trading that is established by buying an at-the-money call while simultaneously writing a higher striking out-ofthe-money call of the same underlying security and the same expiration month. Example An options trader believes that XYZ stock trading at $42 is going to rally soon and enters a bull call spread by buying a JUL 40 call for $300 and writing a JUL 45 call for $100. The net investment required to put on the spread is a debit of $200. The stock price of XYZ begins to rise and closes at $46 on expiration date. Both options expire in-the-money with the JUL 40 call having an intrinsic value of $600 and the JUL 45 call having an intrinsic value of $100. This means that the spread is now worth $500 at expiration. Since the trader had a debit of $200 when he bought the spread, his net profit is $300. If the price of XYZ had declined to $38 instead, both options expire worthless. The trader will lose his entire investment of $200, which is also his maximum possible loss. The Collar A collar is an options trading strategy that is constructed by holding shares of the underlying stock while simultaneously buying protective puts and selling call options against that holding. The puts and the calls are both out-of-the-money options having the same expiration month and must be equal in number of contracts. Example Suppose an options trader is holding 100 shares of the stock XYZ currently trading at $48 in June. He decides to establish a collar by writing a JUL 50 covered call for $2 while simultaneously purchases a JUL 45 put for $1. Since he pays $4800 for the 100 shares of XYZ, another $100 for the put but receives $200 for selling the call option, his total investment is $4700. On expiration date, the stock had rallied by 5 points to $53. Since the striking price of $50 for the call option is lower than the trading price of the stock, the call is assigned and the trader sells the shares for $5000, resulting in a $300 profit ($5000 minus $4700 original investment). However, what happens should the stock price had gone down 5 points to $43 instead? Let's take a look. At $43, the call writer would have had incurred a paper loss of $500 for holding the 100 shares of XYZ but because of the JUL 45 protective put, he is able to sell his shares for $4500 instead of $4300. Thus, his net loss is limited to only $200 ($4500 minus $4700 original investment). Had the stock price remain stable at $48 at expiration, he will still net a paper gain of $100 since he only paid a total of $4700 to acquire $4800 worth of stock.

Call Backspread The call backspread (reverse call ratio spread) is a bullish strategy in options trading that involves selling a number of call options and buying more call options of the same underlying stock and expiration date at a higher strike price. It is an unlimited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience significant upside movement in the near term. A 2:1 call backspread can be implemented by selling a number of calls at a lower strike and buying twice the number of calls at a higher strike. Example Suppose XYZ stock is trading at $43 in June. An options trader executes a 2:1 call backspread by selling a JUL 40 call for $400 and buying two JUL 45 calls for $200 each. The net debit/credit taken to enter the trade is zero. On expiration in July, if XYZ stock is trading at $45, both the JUL 45 calls expire worthless while the short JUL 40 call expires in the money with $500 in intrinsic value. Buying back this call to close the position will result in the maximum loss of $500 for the options trader. If XYZ stock rallies and is trading at $50 on expiration in July, all the options will expire in the money. The short JUL 40 call is worth $1000 and needs to be bought back to close the position. Since the two JUL 45 call bought is now worth $500 each, their combined value of $1000 is just enough to offset the losses from the written call. Therefore, he achieves breakeven at $50. Beyond $50 though, there will be no limit to the gains possible. For example, at $60, each long JUL 45 call will be worth $1500 while his single short JUL 40 call is only worth $2000, resulting in a profit of $1000. If the stock price had dropped to $40 or below at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss.

Bull Calendar Spread Using calls, the bull calendar spread strategy can be setup by buying long term slightly out-of-the-money calls and simultaneously writing an equal number of near month calls of the same underlying security with the same strike price. The options trader applying this strategy is bullish for the long term and is selling the near month calls with the the intention to ride the long term calls for free. Example In June, an options trader believes that XYZ stock trading at $40 is going to rise gradually over the next four months. He enters a bull calendar spread by buying an OCT 45 out-of-the-money call for $200 and writing a JUL 45 out-of-the-money call for $100. The net investment required to put on the spread is a debit of $100. In July, The stock price of XYZ goes up to $42 and the JUL 45 call expires worthless. Subsequently, the price of XYZ stock rises to $49 in October. The OCT 45 call expires in the money and is worth $400 on expiration. Since the initial debit taken to enter the trade is $100, his profit comes to $300. Suppose the price of XYZ did not rise much and remains at or below $45 all the way until expiration of the long term call in October, the trader will lose the initial debit of $100 as both calls expire worthless.

Covered Calls The covered call is a strategy in options trading whereby a call option is sold against a holding of the underlying stock. The writer of a covered call is typically slightly bullish or neutral toward the underlying security. The covered call writer's profit potential is limited as he had, in return for the premium, given up the chance to fully profit from a substantial rise in the price of the underlying asset. Naked Puts or Uncovered Put Writing Writing uncovered puts is an options trading strategy involving the selling of put options without shorting the obligated shares of the underlying stock. Also known as naked put writing, this is a bullish options strategy that is executed to earn a consistent profits by ongoing collection of premiums. Example Suppose XYZ stock is trading at $45 in June. An options trader writes an uncovered JUL 45 put for $200. If XYZ stock rallies to $50 on expiration, the JUL 45 put expires worthless and the trader gets to keep the $200 in premim as profit. This is also his maximum profit and is achieved as long as XYZ stock trades above $45 on options expiration date. If instead XYZ stock drops to $40 on expiration, then the JUL 45 put expires in the money with $500 in intrinsic value. The JUL 45 put needs to be bought back for $500 and subtracting the initial credit of $200 taken, the resulting net loss is $300 Covered Straddle The covered straddle is a bullish strategy in options trading that involves the simultaneous selling of equal number of puts and calls of the same underlying stock, striking price and expiration date while owning the underlying stock. Note that only the call options are covered. Covered straddles are limited profit, unlimited risk options strategies similar to the writing of covered calls. Another way to describe a covered straddle is that it is simply a combination of a covered call write and a naked put write. Since the naked put write has a risk/reward profile of a covered call, a covered straddle can also be thought of as the equivalent of two covered calls.

Example Suppose XYZ stock is trading at $54 in June. An options trader enters a covered straddle by selling a JUL 55 put for $300 and a JUL 55 call for $400 while purchasing 100 shares of XYZ for $5400. The total premiums received for selling the options is $700. On expiration in July, if XYZ stock rallies above the strike price to $57, the JUL 55 put expires worthless while the JUL 55 call expires in the money and the 100 shares get called away for $5500, producing a gain of $100. Including the $700 in premiums received upon entering the trade, the total profit comes to $800 which is also the maximum profit attainable. However, if the stock price drops below the breakeven to $45, the JUL 55 call expires worthless but the naked JUL 55 put and long stock position suffer large losses. The short JUL 55 put is now worth $1000 and needs to be bought back while the long stock position has lost $900 in value. Factoring in the $700 premiums received earlier, the total loss comes to $1200.

Bearish Strategies Put Buying The long put is a simple strategy in options trading that involves the purchase of a put option. The options trader employing the long put strategy believes that the price of the underlying stock will go down beyond a certain price before the expiration date. Bear Put Spread This strategy requires the options trader to buy a higher striking in-the-money put option and sell a lower striking out-of-the-money put option on the same stock with the same expiration date. Also known as a vertical bear put spread. Put Backspread The put backspread (reverse put ratio spread) is a bearish strategy in options trading that involves selling a number of put options and buying more put options of the same underlying stock and expiration date at a lower strike price. It is an unlimited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience significant downside movement in the near term. A 2:1 put backspread can be implemented by buying a number of puts at a higher strike and buying twice the number of calls at a lower strike. Example Suppose XYZ stock is trading at $48 in June. An options trader executes a 2:1 put backspread by selling a JUL 50 put for $400 and buying two JUL 45 puts for $200 each. The net debit/credit taken to enter the trade is zero. On expiration in July, if XYZ stock is trading at $45, both the JUL 45 puts expire worthless while the short JUL 50 put expires in the money with $500 in intrinsic

value. Buying back this put to close the position will result in the maximum loss of $500 for the options trader. If XYZ stock drops to $40 on expiration in July, all the options will expire in the money. The short JUL 50 put is worth $1000 and needs to be bought back to close the position. Since the two JUL 45 puts bought is now worth $500 each, their combined value of $1000 is just enough to offset the losses from the written put. Therefore, he achieves breakeven at $40. Below $40 though, there will be no limit to the gains possible. For example, at $30, each long JUL 45 put will be worth $1500 while his single short JUL 50 put is only worth $2000, resulting in a profit of $1000. If the stock price had rallied to $50 or higher at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss. Covered Puts or Covered Put Writing Writing covered puts is a bearish options trading strategy involving the writing of put options while shorting the obligated shares of the underlying stock. Example Suppose XYZ stock is trading at $45 in June. An options trader writes a covered put by selling a JUL 45 put for $200 while shorting 100 shares of XYZ stock. The net credit taken to enter the position is $200, which is also his maximum possible profit. On expiration in July, XYZ stock is still trading at $45. The JUL 45 put expires worthless while the trader covers his short position with no loss. In the end, he gets to keep the entire credit taken as profit. If instead XYZ stock drops to $40 on expiration, the short put will expire in the money and is worth $500 but this loss is offset by the $500 gain in the short stock position. Thus, the profit is still the initial credit of $200 taken on entering the trade. However, should the stock rally to $55 on expiration, a significant loss results. At this price, the short stock position taken when XYZ stock was trading at $45 suffers a $1000 loss. Subtracting the initial credit of $200 taken, the resulting loss is $800.

Naked Calls or Naked Call Writing The naked call write is a risky options trading strategy where the options trader sells calls against stock which he does not own. Also known as uncovered call writing. The options trader must be careful in the selection of the strike price of the call to be written as it has a significant impact to the profit/loss potential of the trade. If one is neutral to mildly bearish on the underlying, one would execute a premium collection strategy by writing out-of-the-money naked calls. If one is bearish to very bearish, then one would write deep-in-the-money naked calls as an alternative to shorting the underlying stock. Neutral Strategies Ratio Spread The ratio spread is a neutral strategy in options trading that involves buying a number of options and selling more options of the same underlying stock and expiration date at a different strike price. It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term. Call Ratio Spread Using calls, a 2:1 call ratio spread can be implemented by buying a number of calls at a lower strike and selling twice the number of calls at a higher strike. Example Suppose XYZ stock is trading at $43 in June. An options trader executes a 2:1 ratio call spread by buying a JUL 40 call for $400 and selling two JUL 45 calls for $200 each. The net debit/credit taken to enter the trade is zero. On expiration in July, if XYZ stock is trading at $45, both the JUL 45 calls expire worthless while the long JUL 40 call expires in the money with $500 in intrinsic value. Selling or exercising this long call will give the options trader his maximum profit of $500. If XYZ stock rallies and is trading at $50 on expiration in July, all the options will expire in the money but because the trader has written more calls than he has bought, he will need to buy back the written calls which have increased in value. Each JUL 45 call written is now worth $500. However, his long JUL 40 call is worth $1000 and is just enough to offset the losses from the written calls. Therefore, he achieves breakeven at $50. Beyond $50 though, there will be no limit to the loss possible. For example, at $60, each written JUL 45 call will be worth $1500 while his single long JUL 40 call is only worth $2000, resulting in a loss of $1000. However, there is no downside risk to this trade. If the stock price had dropped to $40 or below at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss.

Put Ratio Spread The put ratio spread is a neutral strategy in options trading that involves buying a number of put options and selling more put options of the same underlying stock and expiration date at a different strike price. It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term. A 2:1 put ratio spread can be implemented by buying a number of puts at a higher strike and selling twice the number of puts at a lower strike. Example Suppose XYZ stock is trading at $48 in June. An options trader executes a 2:1 ratio put spread by buying a JUL 50 put for $400 and selling two JUL 45 puts for $200 each. The net debit/credit taken to enter the trade is zero. On expiration in July, if XYZ stock is trading at $45, both the JUL 45 puts expire worthless while the long JUL 50 put expires in the money with $500 in intrinsic value. Selling or exercising this long put will give the options trader his maximum profit of $500. If XYZ stock price drops and is trading at $40 on expiration in July, all the options will expire in the money but because the trader has written more puts than he has purchased, he will need to buy back the written puts which have increased in value. Each JUL 45 put written is now worth $500. However, his long JUL 50 put is worth $1000 and is just enough to offset the losses from the written puts. Therefore, he achieves breakeven at $40. Below $40, there will be no limit to the maximum possible loss. For example, at $30, each of the two written JUL 45 puts will be worth $1500 while his single long JUL 50 put is only worth $2000, resulting in a loss of $1000. However, there is no upside risk to this trade. If the stock price had rallied to $50 or higher at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss. The Straddle Long Straddle (or Buy Straddle) The long straddle, also known as buy straddle or simply "straddle", is a neutral strategy in options trading that involve the simultaneously buying of a put and a call of the same underlying stock, striking price and expiration date. Long straddles are unlimited profit, limited risk options trading strategies that are used when the options trader thinks that the underlying securities will experience significant volatility in the near term.

Example Suppose XYZ stock is trading at $40 in June. An options trader enters a long straddle by buying a JUL 40 put for $200 and a JUL 40 call for $200. The net debit taken to enter the trade is $400, which is also his maximum possible loss. If XYZ stock is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the JUL 40 call expires in the money and has an intrinsic value of $1000. Subtracting the initial debit of $400, the long straddle trader's profit comes to $600. On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 call expire worthless and the long straddle trader suffers a maximum loss which is equal to the initial debit of $400 taken to enter the trade. Short Straddle (or Sell Straddle) The short straddle - a.k.a. sell straddle or naked straddle sale - is a neutral options strategy that involve the simultaneous selling of a put and a call of the same underlying stock, striking price and expiration date. Short straddles are limited profit, unlimited risk options trading strategies that are used when the options trader thinks that the underlying securities will experience little volatility in the near term. Example Suppose XYZ stock is trading at $40 in June. An options trader enters a short straddle by selling a JUL 40 put for $200 and a JUL 40 call for $200. The net credit taken to enter the trade is $400, which is also his maximum possible profit. If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 40 put will expire worthless but the JUL 40 call expires in the money and has an intrinsic value of $1000. Subtracting the initial credit of $400, the short straddle trader's loss comes to $600. On expiration in July, if XYZ stock is still trading at $40, both the JUL 40 put and the JUL 40 call expire worthless and the short straddle trader gets to keep the entire initial credit of $400 taken to enter the trade as profit.

The Strangle Long Strangle (or Buy Strangle) The long strangle, also known as buy strangle or simply "strangle", is a neutral strategy in options trading that involve the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date. It is an unlimited profit, limited risk strategy that is taken when the options trader thinks that the underlying stock will experience significant volatility in the near term. The long strangle is a debit spread as a net debit is taken to enter the trade. Example Suppose XYZ stock is trading at $40 in June. An options trader executes a long strangle by buying a JUL 35 put for $100 and a JUL 45 call for $100. The net debit taken to enter the trade is $200, which is also his maximum possible loss.

If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 35 put will expire worthless but the JUL 45 call expires in the money and has an intrinsic value of $500. Subtracting the initial debit of $200, the options trader's profit comes to $300. On expiration in July, if XYZ stock is still trading at $40, both the JUL 35 put and the JUL 45 call expire worthless and the options trader suffers a maximum loss which is equal to the initial debit of $200 taken to enter the trade. Short Strangle (or Sell Strangle) The short strangle, also known as sell strangle, is a neutral strategy in options trading that involve the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date. It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term. The short strangle is a credit spread as a net credit is taken to enter the trade. Example Suppose XYZ stock is trading at $40 in June. An options trader executes a short strangle by selling a JUL 35 put for $100 and a JUL 45 call for $100. The net credit taken to enter the trade is $200, which is also his maximum possible profit. If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 35 put will expire worthless but the JUL 45 call expires in the money and has an intrinsic value of $500. Subtracting the initial credit of $200, the options trader's loss comes to $300. On expiration in July, if XYZ stock is still trading at $40, both the JUL 35 put and the JUL 45 call expire worthless and the options trader gets to keep the entire initial credit of $200 taken to enter the trade as profit. The Butterfly Butterfly Spread The butterfly spread is a neutral strategy that is a combination of a bull spread and a bear spread. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a butterfly spread and it can be constructed using calls or puts. Long Call Butterfly Long butterflies are entered when the investor thinks that the underlying stock will not rise or fall much by expiration. Using calls, the long butterfly can be constructed by buying one lower striking in-the-money call, writing two at-themoney calls and buying another higher striking out-of-the-money call. A resulting net debit is taken to enter the trade. Example Suppose XYZ stock is trading at $40 in June. An options trader executes a long call butterfly by purchasing a JUL 30 call for $1100, writing two JUL 40 calls for

$400 each and purchasing another JUL 50 call for $100. The net debit taken to enter the position is $400, which is also his maximum possible loss. On expiration in July, XYZ stock is still trading at $40. The JUL 40 calls and the JUL 50 call expire worthless while the JUL 30 call still has an intrinsic value of $1000. Subtracting the initial debit of $400, the resulting profit is $600, which is also the maximum profit attainable. Maximum loss results when the stock is trading below $30 or above $50. At $30, all the options expires worthless. Above $50, any "profit" from the two long calls will be neutralised by the "loss" from the two short calls. In both situations, the butterfly trader suffers maximum loss which is the initial debit taken to enter the trade. Long Put Butterfly The long put butterfly spread is a neutral strategy that is a combination of a bull put spread and a bear put spread. It is a limited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will not rise or fall much by expiration. There are 3 striking prices involved in a long put butterfly spread and it is constructed by buying one lower striking put, writing two at-the-money puts and buying another higher striking put for a net debit. Example Suppose XYZ stock is trading at $40 in June. An options trader executes a long put butterfly by buying a JUL 30 put for $100, writing two JUL 40 puts for $400 each and buying another JUL 50 put for $1100. The net debit taken to enter the trade is $400, which is also his maximum possible loss. On expiration in July, XYZ stock is still trading at $40. The JUL 40 puts and the JUL 30 put expire worthless while the JUL 50 put still has an intrinsic value of $1000. Subtracting the initial debit of $400, the resulting profit is $600, which is also the maximum profit attainable. Maximum loss results when the stock is trading below $30 or above $50. At $50, all the options expires worthless. Below $30, any "profit" from the two long puts will be neutralised by the "loss" from the two short puts. In both situations, the long put butterfly trader suffers maximum loss which is equal to the initial debit taken to enter the trade. Short Butterfly The short butterfly is a neutral strategy like the long butterfly but bullish on volatility. It is a limited profit, limited risk options trading strategy. There are 3 striking prices involved in a short butterfly spread and it can be constructed using calls or puts.

Short Call Butterfly Using calls, the short butterfly can be constructed by writing one lower striking call, buying two at-the-money calls and writing another higher striking call, giving the trader a net credit to enter the position. Example Suppose XYZ stock is trading at $40 in June. An options trader executes a short call butterfly by writing a JUL 30 call for $1100, buying two JUL 40 calls for $400 each and writing another JUL 50 call for $100. The net credit taken to enter the position is $400, which is also his maximum possible profit. On expiration in July, XYZ stock has dropped to $30. All the options expire worthless and the short butterfly trader gets to keep the entire initial credit taken of $400 as profit. This is also the maximum profit attainable and is also obtained even if the stock had instead rallied to $50 or beyond. On the downside, should the stock price remains at $40 at expiration, maximum loss will be incurred. At this price, all except the lower striking call expires worthless. The lower striking call sold short would have a value of $1000 and needs to be bought back. Subtracting the initial credit of $400 taken, the net loss (maximum) is equal to $600. Short Put Butterfly The short put butterfly is a neutral strategy like the long put butterfly but bullish on volatility. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a short put butterfly and it can be constructed by writing one lower striking out-of-the-money put, buying two at-the-money puts and writing another higher striking in-the-money put, giving the options trader a net credit to put on the trade. Example Suppose XYZ stock is trading at $40 in June. An options trader executes a short put butterfly by writing a JUL 30 put for $100, buying two JUL 40 puts for $400 each and writing another JUL 50 put for $1100. The net credit taken to enter the position is $400, which is also his maximum possible profit. On expiration in July, XYZ stock has dropped to $30. All the options expire worthless and the short put butterfly trader gets to keep the entire initial credit taken of $400 as profit. This is also the maximum profit attainable and is also obtained even if the stock had instead rallied to $50 or beyond. On the downside, should the stock price remains at $40 at expiration, maximum loss will be incurred. At this price, all except the higher striking put expires worthless. The higher striking put sold short would have a value of $1000 and needs to be bought back to close the trade. Subtracting the initial credit of $400 taken, the net loss (maximum) is equal to $600.

The Condor The condor is a neutral strategy similar to the butterfly in that it is also a limited risk, limited profit trading strategy that is structured to earn a profit when the underlying stock is perceived to have little volatility. Using calls, the options trader can setup a long condor by combining a bull call spread and a bear call spread. The trader enters a long call condor by writing a lower strike in-the-money call, buying an even lower striking in-the-money call, writing a higher strike out-of-the-money call and buying another even higher striking out-of-the-money call. A total of 4 legs are involved in this trading strategy and it requires a net debit to enter the trade. Example Suppose XYZ stock is trading at $45 in June. An options trader executes a condor by buying a JUL 35 call for $1100, writing a JUL 40 call for $700, writing another JUL 50 call for $200 and buying another JUL 55 call for $100. The net debit required to enter the trade is $300, which is also his maximum possible loss. To further see why $300 is the maximum possible loss, lets examine what happens when the stock price falls to $35 or rise to $55 on expiration. At $35, all the options expire worthless, so the initial debit taken of $300 is his maximum loss. At $55, the long JUL 55 call expires worthless while the long JUL 35 call worth $2000 is used to offset the loss from the short JUL 40 call (worth $1500) and the short JUL 50 call (worth $500). Thus, the long condor trader still suffers the maximum loss that is equal to the $300 initial debit taken when entering the trade. If instead on expiration in July, XYZ stock is still trading at $45, only the JUL 35 call and the JUL 40 call expires in the money. With his long JUL 35 call worth $1000 to offset the short JUL 40 call valued at $500 and the initial debit of $300, his net profit comes to $200. The condor's maximum profit may be low in relation to other trading strategies but it has a comparatively wider profit zone. In this example, maximum profit is achieved if the underlying stock price at expiration is anywhere between $40 and $50. Short Condor The short condor is a neutral strategy similar to the short butterfly. It is a limited risk, limited profit trading strategy that is structured to earn a profit when the underlying stock is perceived to be making a sharp move in either direction. Using calls, the options trader can setup a short condor by combining a bear call spread and a bull call spread. The trader enters a short call condor by buying a lower strike in-the-money call, selling an even lower striking in-the-money call, buying a higher strike out-of-the-money call and selling another even higher striking out-of-the-money call. A total of 4 legs are involved in this trading strategy and a net credit is received on entering the trade.

Example Suppose XYZ stock is trading at $45 in June. An options trader executes a short condor by selling a JUL 35 call for $1100, buying a JUL 40 call for $700, buying another JUL 50 call for $200 and selling another JUL 55 call for $100. A net credit of $300 is received on entering the trade. To further see why $300 is the maximum possible profit, lets examine what happens when the stock price falls to $35 or rise to $55 on expiration. At $35, all the options expire worthless, so the initial credit taken of $300 is his maximum profit. At $55, the short JUL 55 call expires worthless while the profit from the long JUL 40 call (worth $1500) and the long JUL 50 call (worth $500) is used to offset the short JUL 35 call worth $2000 . Thus, the short condor trader still earns the maximum profit that is equal to the $300 initial credit taken when entering the trade. On the flip side, if XYZ stock is still trading at $45 on expiration in July, only the JUL 35 call and the JUL 40 call expire in the money. With his long JUL 40 call worth $500 and the initial credit of $300 received to offset the short JUL 35 call valued at $1000, there is still a net loss of $200. This is the maximum possible loss and is suffered when the underlying stock price at expiration is anywhere between $40 and $50.

The Iron Butterfly The iron butterfly spread is a neutral strategy that is a combination of a bull put spread and a bear call spread. It is a limited risk, limited profit trading strategy that is structured for a larger probability of earning smaller limited profit when the underlying stock is perceived to have a low volatility. To setup an iron butterfly, the options trader buys a lower strike out-of-themoney put, sells a middle strike at-the-money put, sells a middle strike at-themoney call and buys another higher strike out-of-the-money call. This results in a net credit to put on the trade Example Suppose XYZ stock is trading at $40 in June. An options trader executes an iron butterfly by buying a JUL 30 put for $50, writing a JUL 40 put for $300, writing another JUL 40 call for $300 and buying another JUL 50 call for $50. The net credit received when entering the trade is $500, which is also his maximum possible profit. On expiration in July, XYZ stock is still trading at $40. All the 4 options expire worthless and the options trader gets to keep the entire credit received as profit. This is also his maximum possible profit. If XYZ stock is instead trading at $30 on expiration, all the options except the JUL 40 put sold expire worthless. The JUL 40 put will have an intrinsic value of $1000. This option has to be bought back to exit the trade. Thus, subtracting his initial $500 credit received, the options trader suffers his maximum possible loss of $500. This maximum loss situation also occurs if the stock price had gone up to $50 or beyond instead. To further see why $500 is the maximum possible loss, lets examine what happens when the stock price falls below $30 to $25 on expiration. At this price, only the JUL 30 put and the JUL 40 put options expire in-the-money. The long JUL 30 put has an intrinsic value of $500 while the short JUL 40 put is worth $1500. Selling the long put for $500, and factoring in the intial credit of $500 received, he still need to fork out another $500 to buy back the short put worth $1500. Thus his maximum loss is still $500. The Iron Condor The iron condor is a neutral strategy that is a combination of a bull put spread and a bear call spread. It is a limited risk, limited profit trading strategy that is structured for a larger probability of earning smaller limited profit when the underlying stock is perceived to have a low volatility. To setup an iron condor, the options trader sells a lower strike out-of-the-money put, buys an even lower strike out-of-the-money put, sells a higher strike out-ofthe-money call and buys another even higher strike out-of-the-money call. This results in a net credit to put on the trade.

Example Suppose XYZ stock is trading at $45 in June. An options trader executes an iron condor by buying a JUL 35 put for $50, writing a JUL 40 put for $100, writing another JUL 50 call for $100 and buying another JUL 55 call for $50. The net credit received when entering the trade is $100, which is also his maximum possible profit. On expiration in July, XYZ stock is still trading at $45. All the 4 options expire worthless and the options trader gets to keep the entire credit received as profit. This is also his maximum possible profit. If XYZ stock is instead trading at $35 on expiration, all the options except the JUL 40 put sold expire worthless. The JUL 40 put has an intrinsic value of $500. This option has to be bought back to exit the trade. Thus, subtracting his initial $100 credit received, the options trader suffers his maximum possible loss of $400. This maximum loss situation also occurs if the stock price had gone up to $55 instead. To further see why $400 is the maximum possible loss, lets examine what happens when the stock price falls to $30 on expiration. At this price, both the JUL 35 put and the JUL 40 put options expire in-the-money. The long JUL 35 put has an intrinsic value of $500 while the short JUL 40 put is worth $1000. Selling the long put for $500, he still need $500 to buy back the short put. Subtracting the initial credit of $100 received, his loss is still $400. Calendar Straddle The calendar straddle is implemented by selling a near term straddle while buying a longer term straddle with the intention to profit from the rapid time decay of the near term options sold. It is a limited profit, limited risk strategy entered by the options trader who thinks that the underlying stock price will experience very little volatility in the near term. Example In June, an options trader believes that XYZ stock trading at $40 is going to trade sideways over the next month or so. He enters a calendar straddle by buying an OCT 40 call for $200 and an OCT 40 put for $200 while simultaneously writing a JUL 40 call for $100 and a JUL 40 put for $100. The net investment required to implement the strategy is a debit of $200. On near-term option expiration in July, if the stock is still trading at $40, both the written options will expire worthless while the long call and the long put will still be worth $175 each due to a much slower time decay. Selling this long straddle will net $350 to produce an overall profit of $150 after factoring in the $200 initial debit taken. If instead, the price of XYZ stock had skyrocketed to $60 in July, the written near term straddle will be worth $2000 since the written put will expire worthless while the written call now has an intrinsic value of $2000. The long straddle will also be worth $2000 because while the put will be too far out-of-the-money to be worth anything, the long call will be very deep in-the-money and be worth $2000 (time value for the long call will be almost nothing since it is very deep in-the-money). As such, the options trader can sell the long straddle to offset the losses from the short straddle. Hence, his overall loss is the $200 from the initial debit taken to enter the trade.

Greek The Delta The rate of change of the price of an option with respect to its underlying stock price is known as the delta. The delta ranges in value from 0 to 1 for calls (0 to -1 for puts) and reflects the increase or decrease in the price of the option in response to a 1 point movement of the underlying stock price. Far out-of-the-money options have delta values close to 0 while deep in-themoney options have deltas that are close to 1. Up delta , down delta As the delta can change even with very tiny movements of the underlying stock price, it may be more practical to know the up delta and down delta values. For instance, the price of a call option with delta of 0.5 may increase by 0.6 point on a 1 point increase in the underlying stock price but decrease by only 0.4 point when the underlying stock price goes down by 1 point. In this case, the up delta is 0.6 and the down delta is 0.4. Effects of time on the delta As the time remaining to expiration grows shorter, the time value of the option evaporates and correspondingly, the delta of in-the-money options increases while the delta of out-of-the-money options decreases. How volatility affects the delta As volatility rises, the time value of the option goes up and this causes the delta of out-of-the-money options to increase and the delta of in-the-money options to decrease. The Gamma In options trading, gamma is a measure of the rate of change of the delta. The gamma is expressed as a percentage and reflects the change in the delta in response to a one point movement of the underlying stock price. Like the delta, the gamma is constantly changing, even with tiny movements of the underlying stock price. It generally is at its peak value when the stock price is near the strike price of the option and decreases as the option goes deeper into or out of the money. Options that are very deeply into or out of the money have gamma values close to 0. Example Suppose for a stock XYZ, currently trading at $47, there is a FEB 50 call option selling for $2 and let's assume it has a delta of 0.4 and a gamma of 0.1 or 10 percent. If the stock price moves up by $1 to $48, then the delta will be adjusted upwards by 10 percent from 0.4 to 0.5. However, if the stock trades downwards by $1 to $46, then the delta will decrease by 10 percent to 0.3.

Effects of time on the gamma As the time to expiration draws nearer, the gamma of at-the-money options increases while the gamma of in-the-money and out-of-the-money options decreases. Gamma and volatility When volatility is low, the gamma of at-the-money options is high while the gamma for deeply into or out-of-the-money options approaches 0. This phenomenon arises because when volatility is low, the time value of such options are low but it goes up dramatically as the underlying stock price approaches the strike price. When volatility is high, gamma tends to be stable across all strike prices. This is due to the fact that when volatility is high, the time value of deeply in/out-of-themoney options are already quite substantial. Thus, the increase in the time value of these options as they go nearer the money will be less dramatic and hence the low and stable gamma. The Theta Theta is a measurement of the time decay of options. It is the rate at which options lose their value, specifically the time value, as the expiration date draws nearer. Generally expressed as a negative number, the theta reflects the amount by which the option value will decrease every day. Example A call option with a current price of $2 and a theta of -0.05 will experience a drop in price of $0.05 per day. So in two days' time, the price of the option should fall to $1.90. Effects of time on the theta Longer term options have theta of almost 0 as they do not lose value on a daily basis. Theta is higher for shorter term options, especially at-the-money options. This is pretty obvious as such options have the highest time value and thus have more premium to lose each day. Conversely, theta goes up dramatically as options near expiration as time decay is at its greatest during that period. Volatility and its effect on the theta In general, options of high volatility stocks have higher theta than low volatility stocks. This is because the time value premium on these options are higher and so they have more to lose per day.

The Vega Vega is a measure of the impact of changes in the underlying volatility on the option price. Specifically, the vega expresses the change in the price of the option for every 1% change in underlying volatility. Options tend to be more expensive when volatility is higher. Thus, whenever volatility goes up, the price of the option goes up and when volatility drops, the price of the option will also fall. Therefore, when calculating the new option price due to volatility changes, we add the vega when volatility goes up but subtract it when the volatility falls. Example A stock XYZ is trading at $46 in May and a JUN 50 call is selling for $2. Let's assume that the vega of the option is 0.15 and that the underlying volatility is 25%. If the underlying volatility increased by 1% to 26%, then the price of the option should rise to $2 + 0.15 = $2.15. However, if the volatility had gone down by 2% to 23% instead, then the option price should drop to $2 - (2 x 0.15) = $1.70 Time to expiration and the vega The more time remaining to option expiration, the higher the vega. This makes sense as time value makes up a larger proportion of the premium for longer term options and it is the time value that is sensitive to changes in volatility.

Dividend Arbitrage This is an arbitrage strategy whereby the options trader buys both the stock and the equivalent number of put options before ex-dividend and wait to collect the dividend before exercising his put. Example XYZ stock is trading at $90 and is paying $2 in dividend tomorrow. A put with a striking price of $100 is selling for $11. The options trader can enter a riskless dividend arbitrage by purchasing both the stock for $9000 and the put for $1100 for a total of $10100. On ex-dividend, he collects $200 in the form of dividends and exercises his put to sell his stock for $10000, bringing in a total of $10200. Since his initial investment is only $10100, he earns $100 in zero risk profits. Conversion A conversion is an arbitrage strategy in options trading that can be performed for a riskless profit when options are overpriced relative to the underlying stock. To do a conversion, the trader buys the underlying stock and offset it with an equivalent synthetic short stock (long put + short call) position. Example Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at $4 while the JUL 100 put is priced at $3. An arbitrage trader does a conversion by purchasing 100 shares of XYZ for $10000 while simultaneously buying a JUL 100 put for $300 and selling a JUL 100 call for $400. The total cost to enter the trade is $10000 + $300 - $400 = $9900. Assuming XYZ stock rallies to $110 in July, the long JUL 100 put will expire worthless while the short JUL 100 call expires in the money and is assigned. The trader then sells his long stock for $10000 as required. Since his cost is only $9900, there is a $100 profit. If instead XYZ stock had dropped to $90 in July, the short JUL 100 call will expire worthless while the long JUL 100 put expires in the money. The trader then exercises the long put to sell his long stock for $10000, again netting a profit of $100. Reversal A reversal, or reverse conversion, is an arbitrage strategy in options trading that can be performed for a riskless profit when options are underpriced relative to the underlying stock. To do a reversal, the trader short sell the underlying stock and offset it with an equivalent synthetic long stock (long call + short put) position. Example Suppose XYZ stock is trading at $100 in June and the JUL 100 call is priced at $3 while the JUL 100 put is priced at $4. An arbitrage trader does a reversal by short selling 100 shares of XYZ for $10000 while simultaneously buying a JUL 100 call for $300 and selling a JUL 100 put for $400. An initial credit of $10100 is received when entering the trade. If XYZ stock rallies to $110 in July, the short JUL 100 put will expire worthless while the long JUL 100 call expires in the money and is exercised to cover the short stock position for $10000. Since the initial credit received was $10100, the trader ends up with a net profit of $100. If instead XYZ stock had dropped to $90 in July, the long JUL 100 call will expire worthless while the short JUL 100 put expires in the money and is assigned. The

trader then buys back the obligated quantity of stock for $10000 to cover his short stock position, again netting a profit of $100.