In my last article we introduced vanilla options. They have some nice features such as limiting losses for the buyer. However the pure option might be expensive compared to your view of the market or you might find that you want to express a view that is less one-dimensional.

In this article we present some of the most common option strategies. Before describing the strategies we mention some option jargon which helps when describing the strategies: An option is said to be in-the-money ITM if the option would have a value if it was to be exercised immediately. For a call option this would mean that spot is above the strike, whereas for a put option this would mean that spot is below the strike. Likewise, the option is said to be at-the-money ATM if spot and strike are equal, and finally the option is said to be out-the-money OTM , if the immediate exercise value is zero.

The strategies will consist of two or more positions at different strikes. The below strategies are some of the standard option strategies that can be used. Of course there are many others. The strategy parameters are usually tweaked to meet individual needs. Instead of simply buying a call option when you are bullish you can help finance the purchase by selling another call option with the same maturity but with a higher strike hence more OTM.

The benefit is lower cost and thereby lower downside and spot has to move less for the trade to become profitable. On the other hand, the potential gain is capped. It is the same concept as the Call spread.

Options Greeks: Vega Risk and Reward

You buy a put option and to lower the price, sell a put option - in this case, with a lower strike. The dynamics are the same but on the downside.

Note that both call spreads and put spreads are directional strategies, i. A straddle is buying both a put and a call option with the same strike typically close to ATM.

The strategy is used if you expect the spot to move but are uncertain about which direction: However, the position value will decrease if spot stays static, with the biggest loss occuring if spot is the same as the strike at maturity.

Strangles use the same concepts as Straddles but with the strike of the put leg different from the call leg. Both the put and the call leg are typically placed out -the-money. The benefit compared to the straddle is a lower price; however the spot price will have to move more for the trade to become profitable.

This is the combination of a long out-the-money call and a short out-the-money put. The position typically has low initial cost and does not lose money as long as the spot stays above the put strike, however the trade is strongly directional and has unlimited loss. The strategy can be reversed so it is long the put leg and short the call leg. The seagull strategy is similar to the risk reversal but with a bought put further out-the-money thus ensuring a cap on the downside risk.

As with the risk reversal, the positions can be reversed in which case the protection in the seagull is obtained by buying a call option instead of a put. Note that there are three legs in this strategy i. The combination of selling a straddle and buying a strangle. This strategy is used to profit from dull markets where the spot does not move. The long strangle ensures that the downside risk is limited.

This strategy combines some of the best things from options which cannot be achieved by simple spot trading, i. The same concept as the Butterfly, but made by selling a strangle instead of a straddle. The strikes of the sold strangle are within the band of the bought strangle. This strategy can also be seen as selling a put and a call spread with strikes all being out of the money.

The benefit compared to the butterfly is a longer range which pays out the maximal profit for the strategy, but also lower maximum profit. Note that both butterfly and condor are made of 4 legs each.

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