A similar strategy betting on an outsized move in the securities when you expect high volatility uncertainty is to buy a call and buy a put with different strikes and the same expiration—known as a strangle. A strangle requires larger price moves in either direction to profit but is also less expensive than a straddle. Below is an explanation of straddles from my Options for Beginners course:. Spreads use two or more options positions of the same class. They combine having a market opinion speculation with limiting losses hedging. Spreads often limit potential upside as well.
Options Trading Strategies: A Guide for Beginners
Yet these strategies can still be desirable since they usually cost less when compared to a single options leg. Vertical spreads involve selling one option to buy another. Generally, the second option is the same type and same expiration, but a different strike. A bull call spread, or bull call vertical spread, is created by buying a call and simultaneously selling another call with a higher strike price and the same expiration. The spread is profitable if the underlying asset increases in price, but the upside is limited due to the short call strike.
The benefit, however, is that selling the higher strike call reduces the cost of buying the lower one. Similarly, a bear put spread, or bear put vertical spread, involves buying a put and selling a second put with a lower strike and the same expiration. If you buy and sell options with different expirations, it is known as a calendar spread or time spread.
Combinations are trades constructed with both a call and a put. Why not just buy the stock? Maybe some legal or regulatory reason restricts you from owning it. But you may be allowed to create a synthetic position using options. A butterfly consists of options at three strikes, equally spaced apart, where all options are of the same type either all calls or all puts and have the same expiration. In a long butterfly, the middle strike option is sold and the outside strikes are bought in a ratio of buy one, sell two, buy one. If this ratio does not hold, it is not a butterfly.
The outside strikes are commonly referred to as the wings of the butterfly, and the inside strike as the body. The value of a butterfly can never fall below zero. Closely related to the butterfly is the condor - the difference is that the middle options are not at the same strike price. Because options prices can be modeled mathematically with a model such as the Black-Scholes, many of the risks associated with options can also be modeled and understood.
This particular feature of options actually makes them arguably less risky than other asset classes, or at least allows the risks associated with options to be understood and evaluated. Individual risks have been assigned Greek letter names, and are sometimes referred to simply as "the Greeks.
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Below is a very basic way to begin thinking about the concepts of Greeks:. Options do not have to be difficult to understand once you grasp the basic concepts. Options can provide opportunities when used correctly and can be harmful when used incorrectly. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.
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Reading Options Tables. Options Risks. The Bottom Line. Key Takeaways An option is a contract giving the buyer the right, but not the obligation, to buy in the case of a call or sell in the case of a put the underlying asset at a specific price on or before a certain date. People use options for income, to speculate, and to hedge risk. Options are known as derivatives because they derive their value from an underlying asset. A stock option contract typically represents shares of the underlying stock, but options may be written on any sort of underlying asset from bonds to currencies to commodities.
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