APPETIZER: Once your trade is established, the only thing you have to do is monitor your position and remember your trading plan. If you went into the trade with a plan (and I hope that you did) then remember the axiom, âplan your trade, trade your planâ! Because you put all the thought and work into planning the trade before you opened the position, your job is now simply to remember what your plan is and stick to it. Try not to let your emotions enter the trade after it has already been put into action. Remember that you are now a âbusiness ownerâ and your business is trading. You should learn from your losses and gains alike, and if you close the trade and move on without realizing what made the trade work and what did not, then you will not improve as a trader. Trading is a process in which you are continuously learning and adapting, and the closing of a position should be just as educational as the process involved when you enter a trade. h/t Mike Kleinhenz â Kayline Strategies, L.L.C.
MAIN COURSE (basic strategies): Long Call: Bullish. The implied volatility (IV) should be low to purchase relatively cheap options. Allow enough time to expiration for the stock to move and to reduce the effect of time decay. How: Buy (long) XYZ $50 call Maximum Risk: Limited to initial debit paid Maximum Reward: Unlimited. Long Put: Bearish. Expect the stock to move lower. The IV should be low to purchase relatively cheap options. Give the position enough time to expiration to be profitable and reduce the effect of time decay. How: Buy (long) XYZ $50 put Maximum Risk: Limited to initial debit paid Maximum Reward: Substantial, but limited to strike price â debit paid because stock can only fall to $0. Bull Call Spread: Bullish. Expect the stock to move higher. Purchase a call and sell another call at a higher strike price with the same expiration date for a net debit. The short call is covered by the long call so no margin is required. Profit is limited in exchange for reduced risk because credit from the short call reduces the cost of the long call. Use a bull call spread over a long call when the cost of the long call is too high and the stock is expected to move somewhat higher. How: Buy (long) XYZ $50 call + sell (short) XYZ $55 call Maximum Risk: Limited to initial debit paid Maximum Reward: Limited to difference between the strikes minus initial debit paid. Bull Put Spread: Bullish. Sell a put and purchase another put at a lower strike price with the same expiration date for a net credit. Expect the stock to move higher or sideways so that the puts expire worthless and you keep the entire credit collected. Use a short time to expiration to take advantage of the time decay and give the stock less time to move against you. The margin requirement is the difference between strike prices, but credit received can be applied to the margin requirement. How: Sell (short) XYZ $50 put + buy (long) XYZ $45 put Maximum Risk: Limited to difference between strikes; multiplied by # of shares; minus credit received. Maximum Reward: Limited to credit received. Bear Put Spread: Bearish. Expect the stock to move lower. Purchase a put and sell another put at a lower strike price for a net debit. There is no margin requirement because the short put is covered by the long put. Use a bear put spread over a long put when puts are overpriced or the stock is only expected to move somewhat lower. How: Buy (long) XYZ $50 put + sell (short) XYZ $45 put Maximum Risk: Limited to initial debit paid Maximum Reward: Limited to difference between strike price minus debit paid. Bear Call Spread: Bearish. Sell a call and purchase another call at a higher strike price for a net credit. Expect the stock to move lower or sideways so that the calls expire worthless and you keep the entire credit collected. A bear call spread is preferable over a short call because the spread has limited risk as opposed to the unlimited risk of the short call. Use a short time to expiration to take advantage of time decay and give the stock less time to move against you. The margin requirement is the difference between the strike prices, but credit received can be applied to the margin requirement. How: Sell (short) XYZ $50 call + buy (long) XYZ $55 call Maximum Risk: Limited to difference between strikes; multiplied by # of shares; minus credit received Maximum Reward: Limited to credit received.
Long Straddle: Nondirectional strategy. Purchase a call and a put at the same strike price and expiration month. Expect a large price breakout (earnings, news, etcâ¦), but not sure of direction. The position makes money if the stock moves up or down beyond the breakeven points by expiration. Want as much time as possible to expiration to give the stock time to make a large move in either direction and reduce effect of time decay on both options. Best to use before a specific event that will move the stock (earnings, litigation, drastic news events or any kind, etcâ¦) or when the price is expected to break out from a consolidation pattern. How: Buy (long) XYZ $50 call + buy (long) XYZ $50 put Maximum Risk: Limited to combined debit paid Maximum Reward: Unlimited on the upside; limited on the downside to strike minus debit paid because stock can only fall to $0. Long Strangle: Nondirectional strategy. Purchase an OTM call and OTM put. Lower cost than a long straddle, but requires an even greater move in the stock in either direction to be profitable. Establish the position with as much time to expiration as possible to give the stock sufficient time to make the large required move for the position to be profitable and to reduce the effect of time decay on both options. As with straddles, it is best to use before a specific event (earnings, FDA announcement, economic news, litigation, drastic news, etcâ¦) or when the price is expected to break out from a consolidation pattern. How: Buy (long) XYZ $55 call + buy (long) XYZ $45 put Maximum Risk: Limited to combined debit paid Maximum Reward: Unlimited on the upside; limited on the downside to put strike minus combined debit paid because stock can only fall to $0. Short Straddle: Neutral strategy. Sell a call and a put at the same strike price and expiration date. Expect the stock to move sideways until expiration and have options expire worthless or shrink in value. Extremely risky position due to the presence of two naked options. Use as short a time to expiration as possible to take advantage of time decay on both short options and not give the stock time to make a significant move away from the short strike. Margin is required as a result of naked options. How: Sell (short) XYZ $50 call + sell (short) XYZ $50 put Maximum Risk: Unlimited on the upside; limited on the downside to strike price minus combined credit received because stock can only fall to $0. Maximum Reward: Limited to total credit received. Short Strangle: Neutral strategy. Sell an OTM call and an OTM put. Expect the stock to move sideways and be between the short strikes at expiration. Extremely risky position due to the presence of two naked options. A wider profit zone than a short straddle due to the difference between the short strikes, but smaller credit received. Use as short time to expiration as possible to take advantage of the time decay of both OTM options and not give the stock time to move against you. Margin is required due to the presence of naked options, but slightly less than in the case of a short straddle. How: Sell (short) XYZ $55 call + sell (short) XYZ $45 put Maximum Risk: Unlimited on the upside; limited on the downside to lower strike price minus credit received because stock can only fall to $0. Maximum Reward: Limited to total credit received. Call Ratio Spread: Neutral to slightly bullish. Expect the stock to move sideways or slightly upwards. Purchase a call and sell more calls at a higher strike price in a ratio of 1:2 or 1:3. Combination of a bull call spread and naked calls. Recommend that the position be opened for a credit, which removes the potential for loss if the stock moves lower and calls expire worthless. A short time to expiration is preferred to take advantage of the time decay in short options and not give the stock time to move very high in price and produce a loss. Margin is required du to the presence of extra naked calls. How: Buy (long) XYZ $50 call + sell (short) two (or three) XYZ $55 calls (1:2 or 1:3) Maximum Risk: Unlimited on the upside; limited on the downside to initial debit paid or none if position is opened for credit. Maximum Reward: Short call strike price minus long call strike price for a plus/minus credit. Put Ratio Spread: Neutral to slighly bearish. Expect the stock to move sideways or slightly lower. Purchase a put and sell more puts at a lower strike price in a ratio of 1:2 or 1:3. Combination of a bear put spread and naked puts. Recommend that the position be opened for a credit, which removes the potential for loss if the stock moves higher and puts expire worthless. A short time to expiration is preferred to take advantage of the time decay in short options and not give the stock time to move very low in price and produce a loss. Margin is required due to the presence of extra naked puts. How: Buy (long) XYZ $55 put + sell (short) two (or three) XYZ $50 puts Maximum Risk: Downside is substantial but limited to short strike price minus difference between strikes plus/minus credit received/debit paid. Upside is limited to initial debit paid or no risk is position is opened for credit. Maximum Reward: Long put strike minus short put strike plus/minus credit received/debit paid. Call Ratio Backspread: Bullish strategy. Expect the stock to make a large move higher. Purchase calls and sell fewer calls at a lower strike, usually in a ratio of 1:2 or 2:3. The lower strike short calls finance the purchase of the greater number of long calls and the position is usually entered into for no cost or a net credit. The stock has to make a large enough move for the gain in the long calls to overcome the loss in the short calls because the maximum loss is at the long strike at expiration. Because the stock needs to make a large move higher for the backspread to make a profit, use as long a time to expiration as possible. How: Sell (short) XYZ $50 call + buy (long) two XYZ $55 calls Maximum Risk: Long strike minus short strike plus/minus credit received/debit paid. Maximum Reward: Upside is unlimited. Downside is limited to initial credit received if any. Put Ratio Backspread: Bearish strategy. Expect the stock to make a large move lower. Purchase puts and sell fewer puts at a higher strike price, usually in a ratio of 1:2 or 2:3. The higher strike puts finance the purchase of the greater number of long puts and the position is usually entered into for no cost or a net credit. The stock has to make a large enough move lower for the gain in the long puts to overcome the loss in the short puts because the maximum loss is at the long strike at expiration. Because the stock needs to make a large move lower for the backspread to make a profit, use as long a time to expiration as possible. How: Sell (short) XYZ $55 put + buy (long) two XYZ $50 puts (1:2) Maximum Risk: Short strike minus long strike plus/minus debit paid/credit received. Maximum Reward: Downside is substantial, but limited to long strike price minus difference between strikes plus/minus debit/credit. Upside is limited to initial credit received, if any. Long Butterflies: Nondirectional. Bearish or bullish depending on selection of short strikes. Established using all calls or all puts and is done for a net debit. For example, a long call butterfly is created by purchasing a call, selling two calls at a higher strike price, and purchasing another call at an even higher strike with the strike prices evenly spaced apart. The maximum reward occurs when the stock is right at short strikes at expiration. The number of options sold equals the number of options purchased. How: Buy (long) $45 call/put + sell (short) two $50 calls/puts + buy (long) $55 call/put. Maximum Risk: Limited to debit paid Maximum Reward: Difference between long strike and short strike minus debit paid. Short Butterflies: Nondirectional. Expect the stock to make a large move higher or lower but not sure of direction. Established using all calls or puts and is done for a net credit. For example, a short call butterfly is created by selling a call, purchasing two calls at a higher strike price, and selling another call at an even higher strike price, with the strike prices evenly apart. The number of long options equals the number of short options. The maximum reward occurs when the stock moves beyond the breakeven pointsâ¦which are the lowest strike + credit received or highest strike â credit received. How: Sell (short) $45 call/put + buy (long) two $50 calls/puts + sell (short) $55 call/put Maximum Risk: Difference between long and short strikes minus credit received. Maximum Reward: Limited to credit received.
DESSERT: parting words of wisdom for consideration: Remember that most of the successful traders are minimalists, which means that they find one or two strategies that they really like and feel confident with and then simply hammer away at those over and over. The best form of education one can truly achieve is by trial and error. Youâll never really understand how some of these strategies really work until you actually try them. I highly recommend that you attempt to trade some of these strategies that you are not familiar with in your virtual trading account. If you do not have a virtual trading account or if you're not sure what a virtual trading account is then consider looking at and signing up for a FREE account (no strings attached) with the C.B.O.E. by clicking here. Remember that the first priority (especially with a beginning trader) is capital preservation. You canât trade if you lose all of your capital and you donât want to put yourself in a position where one or two trades will make or break you. Be patient with your development and keep in mind that trading these advanced strategies is not very easy and understanding these will take time. Be disciplined with your trading and follow the rules that you have been shown and the ones that you personally develop over time. Good luckâ¦and HAPPY TRADING!!! Books Consulted While Putting This Document Together: - The Option Trader Handbook; George Jabbour and Phillip Budwick - The Complete Option Player; Kenneth R. Trester h/t Mike Kleinhenz â Kayline Strategies, L.L.C. source: http://www.ficiency.com/trading/optioncheatsheet.html