Bull call spread is a moderately bullish strategy where you buy a lower strike call option and sell a higher strike call option of the same expiry. Here, like in any vertical spread contract, the maximum profit and the maximum loss are fixed and hence it is a closed strategy.

Illustration 6 : Trader Buys an August call option of a stock at Rs. This is an example of a bull call spread. Let us see how the payoffs work. Bear Put spread is moderately bearish strategy where you buy a higher strike put option and sell a lower strike put option of the same expiry. Illustration 7 : Trader Buys an August put option of a stock at Rs. This is an example of a bear put spread. Tradebulls Securities is one of the leading Indian financial corporations aimed to make trading easier for everyone, even for those who are from a non-trading background.

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Introduction to Derivatives Trading – Guide to Financial Derivatives

Broadly, options strategies can be divided into 6 categories as under: Bullish strategies Bearish strategies Moderately bullish strategies Moderately bearish strategies Volatile strategies Range bound strategies In the chapter we shall look at various strategies and for greater clarity we will classify them and bucket into one of the above strategy baskets. Protective Puts, Covered Calls and Collars These are the 3 most basic strategies that are used on a regular basis.

Protective Put strategy Assume that you purchased a stock to hold from a long term perspective. The maximum loss on the protective put strategy as we can see is Rs. That is the sum of the gap between spot price and strike price plus the option premium of Rs. However, low the stock price goes, you can never lose more than Rs. That level arises at a price of Rs. That can be interpreted as the purchase price of Rs. Above the BEP, the profits for the trader are unlimited. By just paying a premium of Rs. Covered Call strategy While the protective put is a limited risk strategy, the covered call is not exactly a limited risk strategy.

The maximum profit on the covered call strategy as we can see is Rs. That is the sum of the gap between strike price and spot price plus the option premium of Rs. However, high the stock price goes, your profit ceiling is Rs. Maximum profit always arises at the strike price at which call is sold. Above that, any profit on spot position is negated by losses on the call option sold. However, on the downside, as you can see from the table above, the losses can be unlimited. Hence this strategy must only be adopted on stocks that have strong fundamentals and where you can hold for the long term.

The breakeven point for the covered call strategy is Rs. Below , your net effective losses on the spot position start increasing. Collar strategy In the covered call strategy we saw that the downside risk was open. The maximum loss on the collar strategy, as can be seen in the table above is Rs. However, low the price of the stock goes, your total loss can never be more than Rs. How is this Rs. But this loss of 15 gets reduced by the Rs. Hence maximum loss on the Collar is limited to Rs. On the upside the maximum profit will be limited to Rs. How is this maximum profit arrived at?

You first consider the gap between the call strike price and purchase price To that you add the net premium received The sum is Rs. The breakeven point for the collar strategy is Rs. From the purchase price of Rs. As long as the stock price is above Rs. Straddles, Strangles and Butterfly Spreads Option strategies are fine when you have a view on the direction of the market. Straddle strategy The straddle strategy involves two options of same strike prices and same maturity. Long on straddle is a volatile strategy and it makes a loss only when the stock remains stagnant.

The maximum loss on the long straddle strategy is Rs. Once that premium is covered, then the price movement becomes profitable either way.

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The straddle being a volatile strategy it has two breakeven points. There is a lower breakeven point at Rs. For example, a long butterfly spread can be constructed by purchasing one in-the-money call option at a lower strike price, while also selling two at-the-money call options and buying one out-of-the-money call option. A balanced butterfly spread will have the same wing widths. An investor would enter into a long butterfly call spread when they think the stock will not move much before expiration.

The maximum loss occurs when the stock settles at the lower strike or below or if the stock settles at or above the higher strike call. This strategy has both limited upside and limited downside. In the iron condor strategy, the investor simultaneously holds a bull put spread and a bear call spread. The iron condor is constructed by selling one out-of-the-money put and buying one out-of-the-money put of a lower strike—a bull put spread—and selling one out-of-the-money call and buying one out-of-the-money call of a higher strike—a bear call spread.

All options have the same expiration date and are on the same underlying asset. Typically, the put and call sides have the same spread width.

Introduction to Derivatives Trading – Guide to Financial Derivatives

This trading strategy earns a net premium on the structure and is designed to take advantage of a stock experiencing low volatility. Many traders use this strategy for its perceived high probability of earning a small amount of premium. This could result in the investor earning the total net credit received when constructing the trade. The further away the stock moves through the short strikes—lower for the put and higher for the call—the greater the loss up to the maximum loss. Maximum loss is usually significantly higher than the maximum gain.

This intuitively makes sense, given that there is a higher probability of the structure finishing with a small gain. In the iron butterfly strategy, an investor will sell an at-the-money put and buy an out-of-the-money put. At the same time, they will also sell an at-the-money call and buy an out-of-the-money call.

Although this strategy is similar to a butterfly spread , it uses both calls and puts as opposed to one or the other. It is common to have the same width for both spreads. The long, out-of-the-money call protects against unlimited downside. The long, out-of-the-money put protects against downside from the short put strike to zero.

Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors like this strategy for the income it generates and the higher probability of a small gain with a non-volatile stock.

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The maximum gain is the total net premium received. Maximum loss occurs when the stock moves above the long call strike or below the long put strike. Energy Trading. Advanced Options Trading Concepts. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.

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