Sep 21, 2022
What is your most successful option-trading strategy? What are your favorite 'defined risk' options strategies? Let's take a look at some popular option strategies that many investors use to limit their risk and when you would use them. Already armed with this knowledge? See how easily you can start options trading "complex" strategies like these with Olive. Join today for Free!
Overview
Some strategies using options help investors limit their risk and provide more control over the outcome versus buying and holding an asset.
Combining calls and puts increases chances of winning and makes it harder to lose.
We look at four such strategies here: protective collars, long straddles, strangles, and iron condors.
Options Collar
This is a strategy investors use when they own shares of the asset and creates some upside profit potential when the short-term forecast is bearish but the long-term forecast is bullish.
For protection, you buy a put option below the current stock price, and at the same time sell a corresponding call option to collect premium. Typically out-of-the-money calls and puts are chosen to create a net credit.
If the stock price falls, the put option will provide protection below the strike price until the option expires. If the stock price rises, the potential profit is capped at the strike of the covered call.
Collar Example
Buy 100 shares XYZ stock at 100.00
Sell 1 XYZ 105 call at 1.80
Buy 1 XYZ 95 put at 1.60
Long Straddle
This strategy is used to profit off volatility and is neutral in direction. For this strategy a trader will enter at-the-money options with longer dated expiry and will see the most benefit when the price movement is high.
For this strategy, you buy both call and put options with the same expiry date, strike price and underlying asset. The best time to buy the call/put options is when they are undervalued or discounted. Risk is limited on long straddles, as the maximum loss is equal to the cost of both the options.
In general, you should not keep long straddle options open till the expiry date, as chances of a failure is higher as it approaches maturity.
Long Straddle Example
XYZ stock current price 100.00
Buy 1 XYZ 105 call at 1.80
Buy 1 XYZ 95 put at 1.60
Long Strangle
This strategy is very similar to a long straddle in the way it is constructed and when it is used. The difference is instead of at-the-money strikes, you select out-of-the-money options.
The benefit to a long strangle is the net cost to open the trade is lower. The tradeoff however is that the price movement of the underlier must move much more before you profit.
Long Strangle Example
XYZ stock current price 100.00
Buy 1 XYZ 100 call at 0.05
Buy 1 XYZ 90 put at 0.05
Iron Condor
If straddles and strangles are best for high volatility assets, iron condors are designed for collecting limited profit but with high probability on assets that have low volatility. You can also separate an iron condor into its two parts, a bull put spread plus a bear call spread. Similar to the previous two strategies, this is a directionally neutral options strategy.
Like the options collar, iron condors create a net credit on opening the trade. Using one expiry date, you sell an out-of-the-money put, buy an even lower strike put, sell a out-of-the-money call and buy an even higher strike call.
You would collect maximum profit on an iron condor equal to the premium received when putting on the trade when the underlying stock price at expiration is between the strikes of the short call and put. In this case the options would expire worthless.
Risk is limited on this strategy as the maximum loss is equal to the difference in strike between the long calls (or puts) minus the net credit received when entering the trade.
Iron Condor Example
XYZ stock current price 100.00
Sell 1 XYZ 90 put at 0.05
Buy 1 XYZ 95 put at 0.01
Sell 1 XYZ 100 call at 0.05
Buy 1 XYZ 105 call at 0.01
The Bottom Line
As you can see from the above strategies, options can be used in various ways to generate income while managing risk. Olive makes it easier than ever to optimize option strategies for your investment portfolio.
Every outcome on Olive offers either downside protection or leveraged returns with defined risk.
All Olive strategies create a net credit when putting on the trade.
Multi-leg options strategies are easy to execute with one-click through your linked online brokerage account.
Paper trade these options and see for yourself Olive advantage when compared over time to other trading strategies. Join us today for free and see all your options!
