Options are derivative products that give the right (and not the obligation) to buy (or sell) an underlying asset at a predetermined price. The basis is most often shares, but it can also be a stock index or a commodity.
The most classic options (we’re talking vanilla options) are calls (options to buy) and puts (options to sell). These options can be combined with each other to create an optional strategy.
➡️ In this article we will review some of the most popular option strategies.
Bull and bear spreads
This strategy involves buying and selling two options of the same type and the same exercise date, but with different strikes.
- A bull spread consists of buying a call and selling another at a different strike price.
- A bear spread consists of buying one put and selling another at a different strike price.
In the case of a bullish spread, the investor expects an increase in the price of the underlying security (and vice versa for a bearish spread).
Butterflies and condors
A butterfly corresponds to the purchase of 2 call options (respectively put) and the issuance of a call option (respectively put). Very logically, the payoff has a shape that is all the more Dirac-like when the hits are close. This strategy is chosen by an investor who assumes that the price of the underlying will remain close to the strike and will not move in one direction or the other.
Condor is a butterfly strategy but with 4 strike prices and not 3 as before.
Straddles and Strangles
A straddle is a portfolio composed of a call option and a put option with the same strike price. This strategy is chosen by an investor who thinks that the price of the underlying will vary significantly without knowing exactly in which direction. Conversely, an investor who assumes that the price will remain stable around the value of the bet will choose the opposite strategy.
The strangle is exactly the same type, but the call and put bets are different. The investor is therefore betting on greater fluctuations in the share price. However, the loss if the stock price stays within the central values is lower because the initial investment is lower.
The gain profile of the choke depends on the value separating the two beats. The further apart they are, the smaller the size of the loss will be and the larger the swing in the stock price will be necessary to hope to make a profit. A chokehold sale is sometimes called a peak vertical combination. This can be useful for an investor who believes that a large change in share price is unlikely. However, as with selling a straddle, this is a risky strategy that carries with it an unlimited potential loss for the investor.
Stripes and straps
A strip consists of a call (long position) and two put options with identical strikes and expiration dates. A strap is a long position for two calls and a put with the same strike and the same expiration dates. In the Strip, an investor is betting on a big change in a stock’s price, but believes it is more likely to go down than up. With Strap, the investor is also betting on a large change in the stock’s value. In this case, however, the increase in the share price plays a major role.
Calendar spreads are strategies involving options with different maturity dates but the same bets. These strategies can be useful when the investor expects the movement of the underlying (and possibly the direction of this movement) at a specific moment in the future, for example on the occasion of the publication of company results, macroeconomic information, decisions, etc. The longer the life of the option, the higher its price is generally. Therefore, the calendar spread requires an initial investment. The investor makes a profit if the share price at the expiration of the short-term option is close to the real of the same option. However, a loss is recorded if the share price deviates significantly from this strike price, either upwards or downwards.
In a neutral calendar spread, the strike is chosen very close to the current stock price. A bullish calendar spread involves choosing a strike price higher than the stock price. Finally, a bearish calendar spread expresses a strike option lower than the current share price.
Calendar spreads can be created with both put and call options.
In a reverse calendar spread, the investor buys an option with a short maturity and sells an option with a long maturity. A small profit is made if the stock price is far (above or below) the option strike when the short option expires. However, the investor will suffer a loss if the stock price stays close to this strike.
The Chicago Board Options Exchange offers Flex options on stocks and indices. These are options with non-standard properties. For example, the strikes or maturities are different from those offered in standardized products. In some cases, these options may be European, while the options listed on the organized market are American. Flex options are actually an attempt by the organized markets to reclaim market share from the OTC markets. However, market authorities require a minimum volume to maintain Flex options trading.
A binary or digital call (respectively put) option is an option that pays 1 euro if the price of the underlying share is above (respectively below) the given exercise price on the day of exercise.