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Risk Profiles

Calls

 

Calls can either be bought (long) or sold (short or naked).  Typically, nobody should be naked calls because of the unlimited risk.

When you are long calls you have the right to buy the underlying stock at the specified strike price until the expiration of the option.

When you are short calls you have the obligation to deliver the underlying stock at the specified strike price until the expiration of the option.  American-style options may be exercised early.  Typically you are short calls with a covered call or spread position.

A covered call is where you own the underlying stock and sell a call on that same underlying.

Puts

Puts can either be bought (long) or sold (short or naked).  Typically, nobody should be naked puts because of the large risk (equal to the strike price).

When you are long puts you have the right to sell the underlying stock at the specified strike price until the expiration of the option.

When you are short puts you have the obligation to purchase the underlying stock at the specified strike price until the expiration of the option.

Notice that the risk profile for the covered call is exactly the same as the naked short put.  More will be discussed about that on the Strategy Comparison page.

A protective put is where you own the stock and are long a put on the same underlying stock.  Notice that the risk profile for the protective put is the same as for the long call.

Collar

The collar is where you own the stock accompanied by a long put and a short call - essentially a covered call with a long (or protective) put.

You don't make as much with this trade but you don't lose that much either!!

Straddles

The long straddle is where you own both a call and a put at the same strike price.

 

The short straddle is where you sell both a call and a put at the same strike price.

These straddle trades should be distinguished from what the IRS considers a "Straddle" position.  More will be discussed about that here.

Presented here are some of the more popular and basic option trades.

 

What you will discover is that many of the complex trades are simply combinations of more basic ones.  See Strategy Comparisons for more details.

Each trade can be made more and more complex by layering a strategy, such as, multiple iron condors that span several strikes.

 

Now that is when you are truly trading options!!!

 

The following is a brief overview of option strategies and their respective risk profiles.  No attempt will be made to explain risk, reward, break-even or when to apply these strategies.  This is simply an overview and helps to establish our nomenclature used throughout this website.

Strangles

The long strangle is where you own both a call and a put at different strike prices.

 

The short strangle is where you sell both a call and a put at different strike prices.

Spreads

A spread trade is the simultaneous purchase and sale of two or more securities (call or put) on the same underlying with at least two different strike prices and either the same or multiple expiration dates.

Spread trades may be debit or credit trades and typically if there are different expirations they are called calendar spreads.

Bull call

The bull call or long call spread is a vertical spread where you buy a call at a lower strike price and sell another call at a higher strike price.  This is a debit trade.

Notice that the bull call has the same risk profile as the long call and the collar.

Bear call

The bear call or short call spread is a vertical spread where you buy a call at a higher strike price and sell another call at a lower strike price.  This is a credit trade.

Bull put

The bull put or short put spread is a vertical spread where you sell a put at a higher strike price and buy another put at a lower strike price.  This is a credit trade.

Notice that the risk profile is the same as the bull call and the collar.

Bear put

The bear put or long put spread is a vertical spread where you buy a put at a higher strike price and sell another put at a lower strike price.  This is a debit trade.

Notice that the risk profile is the same as bear call.

Butterflies

The butterfly strategy uses the combination of either all calls, all puts or a combination of calls and puts to construct a neutral trade.

There are three strike prices involved - at the angles - typically one ITM, two ATM and one OTM.  All strikes will share the same expiration.

Long butterfly

 

Using either all calls or all puts; consists of buying a lower strike call or put, selling 2 intermediate strike calls or puts at the same strike and buying a higher strike call/put.

 

The strikes are evenly distributed, ie, the two longs strikes are equidistant from the short strike.

Short butterfly

Using either all calls or all puts;  consists of selling a lower strike, buying 2 intermediate strikes at the same strike price and buying a higher strike.

 

The strikes are evenly distributed, ie, the two shorts strikes are equidistant from the long strike.

Long iron butterfly

 

Uses a bear call coupled with a bull put; consists of buying a lower strike put, selling an intermediate strike put plus selling the same strike call and buying a higher strike call.

 

The strikes are evenly distributed, ie, the two longs strikes are equidistant from the short strikes.

Short iron butterfly

 

Uses a bear put and a bull call - just the opposite of the long iron butterfly.  Consists of selling a lower strike put and buying a higher strike put coupled with buying the same strike call and selling a call at a higher strike.

 

The strikes are evenly distributed, ie, the two shorts strikes are equidistant from the long strikes.

Condors

The condor trading strategy uses the combination of either all calls, all puts or a combination of calls and puts to construct a "wider" neutral trade.

There are four strike prices involved - at the angles - typically two ITM, and two OTM.  Each ITM and OTM options will have different strike prices.  All strikes will share the same expiration.

These are somewhat commission-heavy trades.

Long condor

 

Usually constructed with all calls or puts; consists of a long lower strike, a short strike above the lower, another short strike above that short and an even higher strike long position.

 

The strikes should be evenly distributed, ie, the spread between the lower long and short is the same as the spread between the upper long and short.

Short condor

 

Usually constructed with all calls or puts; consists of a short lower strike, a long strike above the lower, another long strike above that long and an even higher strike short position.

 

The strikes should be evenly distributed, ie, the spread between the lower short and long is the same as the spread between the upper short and long.

Long iron condor

 

Constructed using a bull put and a bear call - in similar fashion to a long iron butterfly.

 

Consists of buying a lower strike put and selling a higher strike put coupled with selling a lower strike call, at a strike price above the short put and then buying a higher strike call.

 

The strikes should be evenly distributed, ie, the spread between the lower short instruments is the same as the spread between the upper long ones.

Short iron condor

 

Constructed using a bear put and a bull call - in similar fashion to a short iron butterfly.

 

Consists of a short lower strike put and a higher strike long put coupled with a short call above the long put strike and a short call above the long call.

 

The strikes should be evenly distributed, ie, the spread between the outside short strikes is the same as the spread between the inside long ones.

Since this website focuses on the taxation of options, as opposed to trading strategies themselves, make sure to read the section on the taxation of option strategies.

 

As stated there, strategies are not actually taxed but the open and close of each option leg traded is potentially subject to tax individually or as part of an assignment or exercise.