Level 3: Option Strategies
Strategy Diagram Objective Risk Value at expiration Profit / Loss Max profit Max loss Breakeven price
profit from increase of S expiring worthless, but loss is Max (0 , ST - X) Max (0 , ST - X) - C0 unlimited C0 X + C0
right to buy S at X limited
bullish position increases if S moves above X because S has to increase
volatility decreasing
Long call
benefits from increasing
volatility
generate premium income max loss unlimited - Max (0 , ST - X) C0 - Max (0 , ST - X) C0 unlimited X + C0
obligation to sell S at X have to sell at price lower than
bearish position ST if buyer exercises increases if S moves below X
Short call
benefits from decreasing volatility increasing
volatility
hedging expiring worthless, but loss is Max (0 , X - ST) Max (0 , X - ST) - P0 X - P0 P0 X - P0
exposure to downside of S, limited
increases if S moves below X because S has to decrease
right to sell S at X volatility decreasing
Long put
bearish position
generate premium income have to buy at price higher - Max (0 , X - ST) P0 - Max (0 , X - ST) P0 X - P0 X - P0
than ST if buyer exercises, but
obligation to buy S at X max loss is limited increases if S moves above X
bullish position
Short put
volatility increasing
S-C 1. Upside is limited, and S ST - Max (0 , ST - X) V T - S 0 + C0 X - S 0 + C0 S 0 - C0 S 0 - C0
(equivalent short P) might get called by buyer
1. Yield enhancement when long S - value call VT - (S0 - C0) X - (S0 - C0) not X because S crosses the
expecting limited upside, OTM 2. S might decline below X, X - breakeven profit line of combined position
Covered call (substantially) without being called, missing
2. Reducing position at a opportunity to sell at current
favorable price ITM favorable price
3. Target price realization,
marginally OTM
S+P P might expire OTM, losing ST + Max (0 , X - ST) VT - S0 - P0 unlimited S0 + P0 - X S0 + P0
(equivalent long C) premium paid VT - (S0 + P0)
most likely OTM (S0 + P0) - X not X because S crosses the
breakeven - X profit line of combined position
Protective put limits downside of S and
retains upside
S+P-C options expiring OTM ST + Max (0 , X1 - ST) VT - S0 X2 - S0 S0 - X1 S0
(combination of protective put - Max (0 , ST - X2 ) Breakeven - X1
and covered call) giving up potential upside gain - (P0 - C0) - (P0 - C0) + (P0 - C0)
by short C if not zero-cost minus net if not zero-cost minus net + (P0 - C0) if not zero-cost add net
fund P with selling of C premium paid premium paid if not zero-cost add net premium paid
Collar holder of S wants defined risk, premium paid
limiting both upside and X2 - breakeven
downside (reducing delta)
both options most likely OTM
with same S and T
, Strategy Diagram Objective Risk Value at expiration Profit / Loss Max profit Max loss Breakeven price
P+C volatility not increasing and Max (0 , X - ST) V T - P 0 - C0 unlimited P 0 + C0 X (P0 + C0)
long equal number of ATM options expiring within band + Max (0 , ST - X)
C and P options with same X, 2 points
T and S negative theta / time decay
Long straddle (FX strangle uses OTM) long options
long volatility / positive vega
-P-C volatility increasing / vega risk - Max (0 , X - ST) V T + P 0 + C0 P 0 + C0 unlimited X (P0 + C0)
short equal number of ATM - Max (0 , ST - X)
C and P options with same X, 2 points
T and S
Short straddle (FX strangle uses OTM)
short volatility / negative vega
C1 - C2 profit limited Max (0 , ST - X1) VT - (C1 - C2) (X2 - X1) - (C1 - C2) (C1 - C2) X1 + (C1 - C2)
2 calls with same S and T but - Max (0 , ST - X2 ) VT - net premium paid (X2 - X1) - net premium paid net premium paid X1 + net premium paid
different X
Bull call spread profit if S increases but with
limited upside and downside
debit spread
P1 - P2 profit limited Max (0 , X1 - ST) VT + (P2 - P1) (P2 - P1) (X2 - X1) - (P2 - P1) X2 - (P2 - P1)
2 puts with same S and T but - Max (0 , X2 - ST) VT + net premium received net premium received (X2 - X1) - net premium X2 - net premium received
different X received
Bull put spread profit if S increases but with
limited upside and downside
credit spread
C2 - C1 profit limited Max (0 , ST - X2) - VT + (C1 - C2) (C1 - C2) (X2 - X1) - (C1 - C2) X1 + (C1 - C2)
2 calls with same S and T but Max (0 , ST - X1) VT + net premium received net premium received (X2 - X1) - net premium X1 + net premium received
different X received
Bear call spread profit if S decreases but with
limited upside and downside
credit spread
P2 - P1 profit limited Max (0 , X2 - ST) VT - (P2 - P1) (X2 - X1) - (P2 - P1) (P2 - P1) X2 - (P2 - P1)
2 puts with same S and T but - Max (0 , X1 - ST) VT - net premium paid (X2 - X1) - net premium paid net premium paid X2 - net premium paid
different X
Bear put spread profit if S decreases but with
limited upside and downside
debit spread
Strategy Diagram Objective Risk Value at expiration Profit / Loss Max profit Max loss Breakeven price
profit from increase of S expiring worthless, but loss is Max (0 , ST - X) Max (0 , ST - X) - C0 unlimited C0 X + C0
right to buy S at X limited
bullish position increases if S moves above X because S has to increase
volatility decreasing
Long call
benefits from increasing
volatility
generate premium income max loss unlimited - Max (0 , ST - X) C0 - Max (0 , ST - X) C0 unlimited X + C0
obligation to sell S at X have to sell at price lower than
bearish position ST if buyer exercises increases if S moves below X
Short call
benefits from decreasing volatility increasing
volatility
hedging expiring worthless, but loss is Max (0 , X - ST) Max (0 , X - ST) - P0 X - P0 P0 X - P0
exposure to downside of S, limited
increases if S moves below X because S has to decrease
right to sell S at X volatility decreasing
Long put
bearish position
generate premium income have to buy at price higher - Max (0 , X - ST) P0 - Max (0 , X - ST) P0 X - P0 X - P0
than ST if buyer exercises, but
obligation to buy S at X max loss is limited increases if S moves above X
bullish position
Short put
volatility increasing
S-C 1. Upside is limited, and S ST - Max (0 , ST - X) V T - S 0 + C0 X - S 0 + C0 S 0 - C0 S 0 - C0
(equivalent short P) might get called by buyer
1. Yield enhancement when long S - value call VT - (S0 - C0) X - (S0 - C0) not X because S crosses the
expecting limited upside, OTM 2. S might decline below X, X - breakeven profit line of combined position
Covered call (substantially) without being called, missing
2. Reducing position at a opportunity to sell at current
favorable price ITM favorable price
3. Target price realization,
marginally OTM
S+P P might expire OTM, losing ST + Max (0 , X - ST) VT - S0 - P0 unlimited S0 + P0 - X S0 + P0
(equivalent long C) premium paid VT - (S0 + P0)
most likely OTM (S0 + P0) - X not X because S crosses the
breakeven - X profit line of combined position
Protective put limits downside of S and
retains upside
S+P-C options expiring OTM ST + Max (0 , X1 - ST) VT - S0 X2 - S0 S0 - X1 S0
(combination of protective put - Max (0 , ST - X2 ) Breakeven - X1
and covered call) giving up potential upside gain - (P0 - C0) - (P0 - C0) + (P0 - C0)
by short C if not zero-cost minus net if not zero-cost minus net + (P0 - C0) if not zero-cost add net
fund P with selling of C premium paid premium paid if not zero-cost add net premium paid
Collar holder of S wants defined risk, premium paid
limiting both upside and X2 - breakeven
downside (reducing delta)
both options most likely OTM
with same S and T
, Strategy Diagram Objective Risk Value at expiration Profit / Loss Max profit Max loss Breakeven price
P+C volatility not increasing and Max (0 , X - ST) V T - P 0 - C0 unlimited P 0 + C0 X (P0 + C0)
long equal number of ATM options expiring within band + Max (0 , ST - X)
C and P options with same X, 2 points
T and S negative theta / time decay
Long straddle (FX strangle uses OTM) long options
long volatility / positive vega
-P-C volatility increasing / vega risk - Max (0 , X - ST) V T + P 0 + C0 P 0 + C0 unlimited X (P0 + C0)
short equal number of ATM - Max (0 , ST - X)
C and P options with same X, 2 points
T and S
Short straddle (FX strangle uses OTM)
short volatility / negative vega
C1 - C2 profit limited Max (0 , ST - X1) VT - (C1 - C2) (X2 - X1) - (C1 - C2) (C1 - C2) X1 + (C1 - C2)
2 calls with same S and T but - Max (0 , ST - X2 ) VT - net premium paid (X2 - X1) - net premium paid net premium paid X1 + net premium paid
different X
Bull call spread profit if S increases but with
limited upside and downside
debit spread
P1 - P2 profit limited Max (0 , X1 - ST) VT + (P2 - P1) (P2 - P1) (X2 - X1) - (P2 - P1) X2 - (P2 - P1)
2 puts with same S and T but - Max (0 , X2 - ST) VT + net premium received net premium received (X2 - X1) - net premium X2 - net premium received
different X received
Bull put spread profit if S increases but with
limited upside and downside
credit spread
C2 - C1 profit limited Max (0 , ST - X2) - VT + (C1 - C2) (C1 - C2) (X2 - X1) - (C1 - C2) X1 + (C1 - C2)
2 calls with same S and T but Max (0 , ST - X1) VT + net premium received net premium received (X2 - X1) - net premium X1 + net premium received
different X received
Bear call spread profit if S decreases but with
limited upside and downside
credit spread
P2 - P1 profit limited Max (0 , X2 - ST) VT - (P2 - P1) (X2 - X1) - (P2 - P1) (P2 - P1) X2 - (P2 - P1)
2 puts with same S and T but - Max (0 , X1 - ST) VT - net premium paid (X2 - X1) - net premium paid net premium paid X2 - net premium paid
different X
Bear put spread profit if S decreases but with
limited upside and downside
debit spread
