Options Strategies

Before you buy or sell options you need a strategy, and before you choose an options strategy, you need to understand how you want options to work in your portfolio. A particular strategy is successful only if it performs in a way that helps you meet your investment goals. In general, we have found that there are typically three types of options traders; income traders, growth traders, and hedgers. Income traders tend to be attracted to various types of credit spreads (discussed below), whereas growth traders are more likely to speculate with debit trades (discussed below). Hedgers on the other hand are looking to protect the risk in their current equity portfolio. Which is your primary interest? In addition, you must ask yourself how much risk you are willing to take in exchange for the potential rewards.

One of the benefits of options is the flexibility they offer - they can complement portfolios in many different ways. So it's worth taking the time to identify a goal that suits you and your financial plan. Once you've chosen a goal, you'll have narrowed the range of strategies to use. As with any type of investment, only some of the strategies will be appropriate for your objective.

Some options strategies, such as writing covered calls, are relatively simple to understand and execute. There are more complicated strategies, however, such as spreads and collars, that require two opening transactions. These strategies are often used to further limit the risk associated with options, but they may also limit potential return. When you limit risk, there is usually a trade-off.

Simple options strategies are usually the way to begin investing with options. By mastering simple strategies, you'll prepare yourself for advanced options trading. In general, the more complicated options strategies are appropriate only for experienced investors.

Before you enter a trade, you should have pre-determined your exit strategy and have a contingency plan in case the trade (underlying security) should move against you. The difference between pro and amateur traders lies primarily in their preparation and attention to detail. Always trade your plan. For example, say you have purchased a three month call option on AAPL in anticipation of its price moving higher. If market conditions are such that AAPL remains stagnant, or moves down in price, at what point will you exit the trade in order to capture some of the remaining premium in the option? If you simply hold until expiration, you may take a 100% loss on the position. Until you are ready to answer such questions, you are not ready to take the trade. Now let's take a look at some of the available strategies offered to options traders.

Options Strategies: Long Call

Purchasing calls has remained the most popular strategy with investors since listed options were first introduced. Before moving into more complex bullish and bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding call options.

Market Opinion: Bullish to Very Bullish

When to Use

This strategy appeals to an investor who is generally more interested in the dollar amount of his initial investment and the leveraged financial reward that long calls can offer. The primary motivation of this investor is to realize financial reward from an increase in price of the underlying security. Experience and precision are key to selecting the right option (expiration and/or strike price) for the most profitable result. In general, the more out-of-the-money the call is the more bullish the strategy, as bigger increases in the underlying stock price are required for the option to reach the break-even point.

As Stock Substitute

An investor who buys a call instead of purchasing the underlying stock considers the lower dollar cost of purchasing a call contract versus an equivalent amount of stock as a form of insurance. The uncommitted capital is "insured" against a decline in the price of the call option's underlying stock, and can be invested elsewhere. This investor is generally more interested in the number of shares of stock underlying the call contracts purchased, than in the specific amount of the initial investment - one call option contract for each 100 shares he wants to own. While holding the call option, the investor retains the right to purchase an equivalent number of underlying shares at any time at the predetermined strike price until the contract expires.

Note: Equity option holders do not enjoy the rights due stockholders - e.g., voting rights, regular cash or special dividends, etc. A call holder must exercise the option and take ownership of the underlying shares to be eligible for these rights.

Benefit

A long call option offers a leveraged alternative to a position in the stock. As the contract becomes more profitable, increasing leverage can result in large percentage profits because purchasing calls generally requires lower up-front capital commitment than with an outright purchase of the underlying stock. Long call contracts offer the investor a pre-determined risk.

Risk vs. Reward

  • Maximum Profit: Unlimited
  • Maximum Loss: Limited Net Premium Paid
  • Upside Profit at Expiration: Stock Price - Strike Price - Premium Paid Assuming Stock Price above BEP

Your maximum profit depends only on the potential price increase of the underlying security; in theory it is unlimited. At expiration an in-the-money call will generally be worth its intrinsic value. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premium initially paid for the call. Whatever your motivation for purchasing the call, weigh the potential reward against the potential loss of the entire premium paid.

Break-Even-Point (BEP)

  • BEP: Strike Price + Premium Paid

Before expiration, however, if the contract's market price has sufficient time value remaining, the BEP can occur at a lower stock price.

Volatility

  • If Volatility Increases: Positive Effect If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" by paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration.

Alternatives Before Expiration

At any given time before expiration, a call option holder can sell the call in the listed options marketplace to close out the position. This can be done to either realize a profitable gain in the option's premium, or to cut a loss.

Alternatives at Expiration

At expiration, most investors holding an in-the-money call option will elect to sell the option in the marketplace if it has value, before the end of trading on the option's last trading day. An alternative is to exercise the call, resulting in the purchase of an equivalent number of underlying shares at the strike price.

Options Strategies: Long Put

A long put can be an ideal tool for an investor who wishes to participate profitably from a downward price move in the underlying stock. Before moving into more complex bearish strategies, an investor should thoroughly understand the fundamentals about buying and holding put options.

Market Opinion: Bearish

When to Use

Purchasing puts without owning shares of the underlying stock is a purely directional strategy used for bearish speculation. The primary motivation of this investor is to realize financial reward from a decrease in price of the underlying security. This investor is generally more interested in the dollar amount of his initial investment and the leveraged financial reward that long puts can offer than in the number of contracts purchased.

Experience and precision are key in selecting the right option (expiration and/or strike price) for the most profitable result. In general, the more out-of-the-money the put purchased is the more bearish the strategy, as bigger decreases in the underlying stock price are required for the option to reach the break-even point.

Benefit

A long put offers a leveraged alternative to a bearish, or "short sale" of the underlying stock, and offers less potential risk to the investor. As with a long call, an investor who purchased and is holding a long put has predetermined, limited financial risk versus the unlimited upside risk from a short stock sale. Purchasing a put generally requires lower up-front capital commitment than the margin required to establish a short stock position. Regardless of market conditions, a long put will never require a margin call. As the contract becomes more profitable, increasing leverage can result in large percentage profits.

Risk vs. Reward

  • Maximum Profit: Limited Only by Stock Declining to Zero
  • Maximum Loss: Limited Premium Paid
  • Upside Profit at Expiration: Strike Price - Stock Price at Expiration - Premium Paid Assuming Stock Price Below BEP

The maximum profit amount can be limited by the stock's potential decrease to no less than zero. At expiration an in-the-money put will generally be worth its intrinsic value. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premium initially paid for the put. Whatever your motivation for purchasing the put, weigh the potential reward against the potential loss of the entire premium paid.

Break-Even-Point (BEP)?

  • BEP: Strike Price - Premium Paid

Before expiration, however, if the contract's market price has sufficient time value remaining, the BEP can occur at a higher stock price.

Volatility

  • If Volatility Increases: Positive Effect If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" when paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls.

Alternatives before expiration

At any given time before expiration, a put option holder can sell the put in the listed options marketplace to close out the position. This can be done to either realize a profitable gain in the option's premium, or to cut a loss.

Alternatives at expiration

At expiration most investors holding an in-the-money put will elect to sell the option in the marketplace if it has value, before the end of trading on the option's last trading day. An alternative is to purchase an equivalent number of shares in the marketplace, exercise the long put and then sell them to a put writer at the option's strike price. The third choice, one resulting in considerable risk, is to exercise the put, sell the underlying shares and establish a short stock position in an appropriate type of brokerage account.

Options Strategies: Covered Call

The covered call is a strategy in which an investor writes a call option contract while at the same time owning an equivalent number of shares of the underlying stock. If this stock is purchased simultaneously with writing the call contract, the strategy is commonly referred to as a "buy-write." If the shares are already held from a previous purchase, it is commonly referred to an "overwrite." In either case, the stock is generally held in the same brokerage account from which the investor writes the call, and fully collateralizes, or "covers," the obligation conveyed by writing a call option contract. This strategy is the most basic and most widely used strategy combining the flexibility of listed options with stock ownership.

Market Opinion: Neutral to Bullish on the Underlying Stock

When to Use

Though the covered call can be utilized in any market condition, it is most often employed when the investor, while bullish on the underlying stock, feels that its market value will experience little range over the lifetime of the call contract. The investor desires to either generate additional income (over dividends) from shares of the underlying stock, and/or provide a limited amount of protection against a decline in underlying stock value.

Benefit

While this strategy can offer limited protection from a decline in price of the underlying stock and limited profit participation with an increase in stock price, it generates income because the investor keeps the premium received from writing the call. At the same time, the investor can appreciate all benefits of underlying stock ownership, such as dividends and voting rights, unless he is assigned an exercise notice on the written call and is obligated to sell his shares. The covered call is widely regarded as a conservative strategy because it decreases the risk of stock ownership.

Risk vs. Reward

  • Maximum Profit: Limited
  • Maximum Loss: Substantial
  • Upside Profit at Expiration if Assigned: Premium Received + Difference (if any) Between Strike Price and Stock Purchase Price
  • Upside Profit at Expiration if Not Assigned: Any Gains in Stock Value + Premium Received

Maximum profit will occur if the price of the underlying stock you own is at or above the call option's strike price, either at its expiration or when you might be assigned an exercise notice for the call before it expires. The risk of real financial loss with this strategy comes from the shares of stock held by the investor. This loss can become substantial if the stock price continues to decline in price as the written call expires. At the call's expiration, loss can be calculated as the original purchase price of the stock less its current market price, less the premium received from initial sale of the call. Any loss accrued from a decline in stock price is offset by the premium you received from the initial sale of the call option. As long as the underlying shares of stock are not sold, this would be an unrealized loss. Assignment on a written call is always possible. An investor holding shares with a low cost basis should consult his tax advisor about the tax ramifications of writing calls on such shares.

Break-Even-Point (BEP)?

  • BEP: Stock Purchase Price - Premium Received

Volatility

  • If Volatility Increases: Negative Effect If Volatility Decreases: Positive Effect

Any effect of volatility on the option's price is on the time value portion of the option's premium.

Time Decay

  • Passage of Time: Positive Effect

With the passage of time, the time value portion of the option's premium generally decreases - a positive effect for an investor with a short option position.

Alternatives before expiration

If the investor's opinion on the underlying stock changes significantly before the written call expires, whether more bullish or more bearish, the investor can make a closing purchase transaction of the call in the marketplace. This would close out the written call contract, relieving the investor of an obligation to sell his stock at the call's strike price. Before taking this action, the investor should weigh any realized profit or loss from the written call's purchase against any unrealized profit or loss from holding shares of the underlying stock. If the written call position is closed out in this manner, the investor can decide whether to make another option transaction to either generate income from and/or protect his shares, to hold the stock unprotected with options, or to sell the shares.

Alternatives at expiration

As expiration day for the call option nears, the investor considers three scenarios and then accordingly makes a decision. The written call contract will either be in-the-money, at-the-money or out-of-the-money. If the investor feels the call will expire in-the-money, he can hope to be assigned an exercise notice on the written contract and sell an equivalent number of shares at the call's strike price. Alternatively, the investor can choose to close out the written call with a closing purchase transaction, canceling his obligation to sell stock at the call's strike price, and retain ownership of the underlying shares. Before taking this action, the investor should weigh any realized profit or loss from the written call's purchase against any unrealized profit or loss from holding shares of the underlying stock. If the investor feels the written call will expire out-of-the-money, no action is necessary. He can let the call option expire with no value and retain the entire premium received from its initial sale. If the written call expires exactly at-the-money, the investor should realize that assignment of an exercise notice on such a contract is possible, but should not be assumed. Consult with your brokerage firm or a financial advisor on the advisability of what action to take in this case.

Options Strategies: Married Put

An investor purchasing a put while at the same time purchasing an equivalent number of shares of the underlying stock is establishing a "married put" position - a hedging strategy with a name from an old IRS ruling.

Market Opinion: Bullish to Very Bullish

When to Use

The investor employing the married put strategy wants the benefits of stock ownership (dividends, voting rights, etc.), but has concerns about unknown, near-term, downside market risks. Purchasing puts with the purchase of shares of the underlying stock is a directional and bullish strategy. The primary motivation of this investor is to protect his shares of the underlying security from a decrease in market price. He will generally purchase a number of put contracts equivalent to the number of shares held.

Benefit

While the married put investor retains all benefits of stock ownership, he has "insured" his shares against an unacceptable decrease in value during the lifetime of the put, and has a limited, predefined, downside market risk. The premium paid for the put option is equivalent to the premium paid for an insurance policy. No matter how much the underlying stock decreases in value during the option's lifetime, the investor has a guaranteed selling price for the shares at the put's strike price. If there is a sudden, significant decrease in the market price of the underlying stock, a put owner has the luxury of time to react. Alternatively, a previously entered stop loss limit order on the purchased shares might be triggered at a time and at a price unacceptable to the investor. The put contract has conveyed to him a guaranteed selling price, and control over when he chooses to sell his stock.

Risk vs. Reward

  • Maximum Profit: Unlimited
  • Maximum Loss: Limited Stock Purchase Price - Strike Price + Premium Paid
  • Upside Profit at Expiration: Gains in underlying share value - Premium Paid

Your maximum profit depends only on the potential price increase of the underlying security; in theory it is unlimited. When the put expires, if the underlying stock closes at the price originally paid for the shares, the investor's loss would be the entire premium paid for the put.

Break-Even-Point (BEP)?

  • BEP: Stock Purchase Price + Premium Paid

Volatility

  • If Volatility Increases: Positive Effect If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" when paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls.

Alternatives before expiration

An investor employing the married put can sell his stock at any time, and/or sell his long put at any time before it expires. If the investor loses concern over a possible decline in market value of his hedged underlying shares, the put option may be sold if it has market value remaining.

Alternatives at expiration

If the put option expires with no value, no action need be taken; the investor will retain his shares. If the option expires in-the-money, the investor can elect to exercise his right to sell the underlying shares at the put's strike price. Alternatively the investor may sell the put option, if it has market value, before the market closes on the option's last trading day. The premium received from the long option's sale will offset any financial loss from a decline in underlying share value.

Options Strategies: Protective Put

An investor who purchases a put option while holding shares of the underlying stock from a previous purchase is employing a "protective put."

Market Opinion: Bullish on the Underlying Stock

When to Use

The investor employing the protective put strategy owns shares of underlying stock from a previous purchase, and generally has unrealized profits accrued from an increase in value of those shares. He might have concerns about unknown, downside market risks in the near term and wants some protection for the gains in share value. Purchasing puts while holding shares of underlying stock is a directional strategy, but a bullish one.

Benefit

Like the married put investor, the protective put investor retains all benefits of continuing stock ownership (dividends, voting rights, etc.) during the lifetime of the put contract, unless he sells his stock. At the same time, the protective put serves to limit downside loss in unrealized gains accrued since the underlying stock's purchase. No matter how much the underlying stock decreases in value during the option's lifetime, the put guarantees the investor the right to sell his shares at the put's strike price until the option expires. If there is a sudden, significant decrease in the market price of the underlying stock, a put owner has the luxury of time to react. Alternatively, a previously entered stop loss limit order on the purchased shares might be triggered at both a time and a price unacceptable to the investor. The put contract has conveyed to him a guaranteed selling price at the strike price, and control over when he chooses to sell his stock.

Risk vs. Reward

  • Maximum Profit: Unlimited
  • Maximum Loss: Limited Strike Price - (Stock Purchase Price + Premium Paid)
  • Upside Profit at Expiration: Gains in Underlying Share Value Since Purchase - Premium Paid

Potential maximum profit for this strategy depends only on the potential price increase of the underlying security; in theory it is unlimited. If the put expires in-the-money, any gains realized from in an increase in its value will offset any decline in the unrealized profits from the underlying shares. On the other hand, if the put expires at- or out-of-the-money the investor will lose the entire premium paid for the put.

Break-Even-Point (BEP)?

  • BEP: Stock Purchase Price + Premium Paid

Volatility

  • If Volatility Increases: Positive Effect If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" when paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls.

Alternatives before expiration

The investor employing the protective put is free to sell his stock and/or his long put at any time before it expires. For instance, if the investor loses concern over a possible decline in market value of his hedged underlying shares, the put option may be sold if it has market value remaining.

Alternatives at expiration

If the put option expires with no value, no action need be taken; the investor will retain his shares. If the option closes in-the-money, the investor can elect to exercise his right to sell the underlying shares at the put's strike price. Alternatively, the investor may sell the put option, if it has market value, before the market closes on the option's last trading day. The premium received from the long option's sale will offset any financial loss from a decline in underlying share value.

Options Strategies: Cash Secured Put

According to the terms of a put contract, a put writer (seller) is obligated to purchase an equivalent number of underlying shares at the put's strike price if assigned an exercise notice on the written contract. Many investors write puts because they are willing to be assigned and acquire shares of the underlying stock in exchange for the premium received from the put's sale. For this discussion, a put writer's position will be considered as "cash-secured" if he has on deposit with his brokerage firm a cash amount (or equivalent) sufficient to cover such a purchase.

Market Opinion: Neutral to Slightly Bullish

When to Use

There are two key motivations for employing this strategy: either as an attempt to purchase underlying shares below current market price, or to collect and keep premium from the sale of puts which expire out-of-the-money and with no value. An investor should write a cash secured put only when he would be comfortable owning underlying shares, because assignment is always possible at any time before the put expires. In addition, he should be satisfied that the net cost for the shares will be at a satisfactory entry point if he is assigned an exercise. The number of put contracts written should correspond to the number of shares the investor is comfortable and financially capable of purchasing. While assignment may not be the objective at times, it should not be a financial burden. This strategy can become speculative when more puts are written than the equivalent number of shares desired to own.

Benefit

The put writer collects and keeps the premium from the put's sale, no matter how much the stock increases or decreases in price. If the writer is assigned, he is then obligated to purchase an equivalent amount of underlying shares at the put's strike price. The premium received from the put's sale will partially offset the purchase price for the stock, and can result in a purchase of shares below the current market price. If the underlying stock price declines significantly and the put writer is assigned, the purchase price for the shares can be above current market price. In this case, the put writer will have an unrealized loss due to the high stock purchase price, but will have upside profit potential if retaining the purchased shares.

Risk vs. Reward

  • Maximum Profit: Limited Premium Received
  • Maximum Loss: Substantial Strike Amount - Premium Received
  • Upside Profit at Expiration: Premium Received from Put Sale
  • Net Stock Purchase Price if Assigned: Strike Price - Premium Received from Put Sale

If the underlying stock increases in price and the put expires with no value, the profit is limited to the premium received from the put's initial sale. On the other hand, an outright purchase of underlying stock would offer the investor unlimited upside profit potential. If the underlying stock declines below the strike price of the put, the investor might be assigned an exercise notice and be obligated to purchase an equivalent number of shares. The net stock purchase price would be the put's strike price less the premium received from the put's sale. This price can be less than current market price for the stock when assignment is made.

The loss potential for this strategy is similar to owning an equivalent number of underlying shares. Theoretically, the stock price can decline to zero. If assignment results in the purchase of stock at a net price greater than the current market price, the investor would incur a loss - unrealized as long as ownership of the shares is retained.

Break-Even-Point (BEP)?

  • BEP: Strike Price - Premium Received from Sale of Put

Volatility

  • If Volatility Increases: Negative Effect If Volatility Decreases: Positive Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Positive Effect

With the passage of time, the time value portion of the option's premium generally decreases - a positive effect for an investor with a short option position.

Alternatives before expiration

If the investor's opinion about the underlying stock changes before the put expires, the investor can buy back the same contract in the marketplace to "close out" his position,thereby realizing a gain or loss. After this is done, no assignment is possible. The investor is relieved from any obligation to purchase underlying stock..

Alternatives at expiration

If the short option has any value when it expires, the investor will most likely be assigned an exercise notice and be obligated to purchase an equivalent number of shares. If owning the underlying shares is not desired, the investor can close out the written put by buying a contract with the same terms in the marketplace. Such a purchase would have to occur before the end of market hours on the option's last trading day, and could result in a realized loss. On the other hand, the investor is obliged to take delivery of the underlying shares at a possible unrealized loss, in the event of assignment.

Options Strategies: Collar

A collar can be established by holding shares of an underlying stock, purchasing a protective put and writing a covered call on that stock. The option portions of this strategy are referred to as a combination. Generally, the put and the call are both out-of-the-money when this combination is established, and have the same expiration month. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. In other words, one collar equals one long put and one written call along with owning 100 shares of the underlying stock. The primary concern in employing a collar is protection of profits accrued from underlying shares rather than increasing returns on the upside.

Market Opinion: Neutral, following a period of appreciation

When to Use

An investor will employ this strategy after accruing unrealized profits from the underlying shares, and wants to protect these gains with the purchase of a protective put. At the same time, the investor is willing to sell his stock at a price higher than current market price so an out-of-the-money call contract is written, covered in this case by the underlying stock.

Benefit

This strategy offers the stock protection of a put. However, in return for accepting a limited upside profit potential on his underlying shares (to the call's strike price), the investor writes a call contract. Because the premium received from writing the call can offset the cost of the put, the investor is obtaining downside put protection at a smaller net cost than the cost of the put alone. In some cases, depending on the strike prices and the expiration month chosen, the premium received from writing the call will be more than the cost of the put. In other words, the combination can sometimes be established for a net credit - the investor receives cash for establishing the position. The investor keeps the cash credit, regardless of the price of the underlying stock when the options expire. Until the investor either exercises his put and sells the underlying stock, or is assigned an exercise notice on the written call and is obligated to sell his stock, all rights of stock ownership are retained.

Risk vs. Reward

This example assumes an accrued profit from the investor's underlying shares at the time the call and put positions are established, and that this unrealized profit is being protected on the downside by the long put. Therefore, discussion of maximum loss does not apply. Rather, in evaluating profit and/or loss below, bear in mind the underlying stock's purchase price (or cost basis). Compare that to the net price received at expiration on the downside from exercising the put and selling the underlying shares, or the net sale price of the stock on the upside if assigned on the written call option. This example also assumes that when the combined position is established, both the written call and purchased put are out-of-the-money.

  • Net Upside Stock Sale Price if assigned on the Written Call:
    • Call's Strike Price + Net Credit Received for Combination or Call's Strike Price - Net Debit Paid for Combination
  • Net Downside Stock Sale Price if Exercising the Long Put:
    • Put's Strike Price + Net Credit Received for Combination, or
    • Put's Strike Price - Net Debit Paid for Combination

If the underlying stock price is between the strike prices of the call and put when the options expire, both options will generally expire with no value. In this case, the investor will lose the entire net premium paid when establishing the combination, or keep the entire net cash credit received when establishing the combination. Balance either result with the underlying stock profits accrued when the spread was established.

Break-Even-Point (BEP)?

In this example, the investor is protecting his accrued profits from the underlying stock with a sale price for the shares guaranteed at the long put's strike price. In this case, consideration of BEP does not apply.

Volatility

  • If Volatility Increases: Effect Varies If Volatility Decreases: Effect Varies

The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value portion of the options' premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.

Time Decay

  • Passage of Time: Effect Varies

The effect of time decay on this strategy varies with the underlying stock's price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the lower strike price of the long put, losses generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the written call, profits generally increase at a faster rate as time passes.

Alternatives before expiration

The combination may be closed out as a unit just as it was established as a unit. To do this, the investor enters a combination order to buy a call with the same contract and sell a put with the same contract terms, paying a net debit or receiving a net cash credit as determined by current option prices in the marketplace.

Alternatives at expiration

If the underlying stock price is between the put and call strike prices when the options expire, the options will generally expire with no value. The investor will retain ownership of the underlying shares and can either sell them or hedge them again with new option contracts. If the stock price is below the put's strike price as the options expire, the put will be in-the-money and have value. The investor can elect to either sell the put before the close of the market on the option's last trading day and receive cash, or exercise the put and sell the underlying shares at the put's strike price. Alternatively, if the stock price is above the call's strike price as the options expire, the short call will be in-the-money and the investor can expect assignment to sell the underlying shares at the strike price. Or, if retaining ownership of the shares is now desired, the investor can close out the short call position by purchasing a call with the same contract terms before the close of trading.

Options Strategies: Bear Put Spread

Establishing a bear put spread involves the purchase of a put option on a particular underlying stock, while simultaneously writing a put option on the same underlying stock with the same expiration month, but with a lower strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a "vertical spread": a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bear put spread, as any spread, can be executed as a "package" in one single transaction, not as separate buy and sell transactions. For this bearish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.

Market Opinion: Moderately Bearish to Bearish

When to Use

Moderately Bearish An investor often employs the bear put spread in moderately bearish market environments, and wants to capitalize on a modest decrease in price of the underlying stock. If the investor's opinion is very bearish on a stock it will generally prove more profitable to make a simple put purchase.

Risk Reduction An investor will also turn to this spread when there is discomfort with either the cost of purchasing and holding the long put alone, or with the conviction of his bearish market opinion.

Benefit

The bear put spread can be considered a doubly hedged strategy. The price paid for the put with the higher strike price is partially offset by the premium received from writing the put with a lower strike price. Thus, the investor's investment in the long put and the risk of losing the entire premium paid for it, is reduced or hedged.

On the other hand, the long put with the higher strike price caps or hedges the financial risk of the written put with the lower strike price. If the investor is assigned an exercise notice on the written put, and must purchase an equivalent number of underlying shares at its strike price, he can sell the purchased put with the higher strike price in the marketplace. The premium received from the put's sale can partially offset the cost of purchasing the shares from the assignment. The net cost to the investor will generally be a price less than current market prices. As a trade-off for the hedge it offers, this written put limits the potential maximum profit for the strategy.

Risk vs. Reward

  • Downside Maximum Profit: Limited Difference Between Strike Prices - Net Debit Paid
  • Maximum Loss: Limited Net Debit Paid

A bear put spread tends to be profitable if the underlying stock decreases in price. It can be established in one transaction, but always at a debit (net cash outflow). The put with the higher strike price will always be purchased at a price greater than the offsetting premium received from writing the put with the lower strike price.

Maximum loss for this spread will generally occur as underlying stock price rises above the higher strike price. If both options expire out-of-the-money with no value, the entire net debit paid for the spread will be lost.

The maximum profit for this spread will generally occur as the underlying stock price declines below the lower strike price, and both options expire in-the-money. This will be the case no matter how low the underlying stock has declined in price. If the underlying stock is in between the strike prices when the puts expire, the purchased put will be in-the-money, and be worth its intrinsic value. The written put will be out-of-the-money, and have no value.

Break-Even-Point (BEP)?

  • BEP: Strike Price of Purchased Put - Net Debit Paid

Volatility

  • If Volatility Increases: Effect Varies If Volatility Decreases: Effect Varies

The effect of an increase or decrease in either the volatility of the underlying stock may be noticed in the time value portion of the options' premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.

Time Decay

  • Passage of Time: Effect Varies

The effect of time decay on this strategy varies with the underlying stock's price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the higher strike price of the purchased put, losses generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the lower strike price of the written put, profits generally increase at a faster rate as time passes.

Alternatives before expiration

A bear put spread purchased as a unit for a net debit in one transaction can be sold as a unit in one transaction in the options marketplace for a credit, if it has value. This is generally the manner in which investors close out a spread before its options expire, in order to cut a loss or realize profit.

Alternatives at expiration

If both options have value, investors will generally close out a spread in the marketplace as the options expire. This will be less expensive than incurring the commissions and transaction costs from a transfer of stock resulting from either an exercise of and/or an assignment on the puts.

If only the purchased put is in-the-money and has value as it expires, the investor can sell it in the market place before the close of the market on the option's last trading day. On the other hand, the investor can exercise the put and either sell an equivalent number of shares that he owns or establish a short stock position.

Options Strategies: Bull Call Spread

Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stock with the same expiration month, at a higher strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a "vertical spread": a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bull call spread, as any spread, can be executed as a"unit" in one single transaction, not as separate buy and sell transactions. For this bullish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.

Market Opinion: Moderately Bullish to Bullish

When to Use

Moderately Bullish An investor often employs the bull call spread in moderately bullish market environments, and wants to capitalize on a modest advance in price of the underlying stock. If the investor's opinion is very bullish on a stock it will generally prove more profitable to make a simple call purchase.

Risk Reduction An investor will also turn to this spread when there is discomfort with either the cost of purchasing and holding the long call alone, or with the conviction of his bullish market opinion.

Benefit

The bull call spread can be considered a doubly hedged strategy. The price paid for the call with the lower strike price is partially offset by the premium received from writing the call with a higher strike price. Thus, the investor's investment in the long call, and the risk of losing the entire premium paid for it, is reduced or hedged.

On the other hand, the long call with the lower strike price caps or hedges the financial risk of the written call with the higher strike price. If the investor is assigned an exercise notice on the written call and must sell an equivalent number of underlying shares at the strike price, those shares can be purchased at a predetermined price by exercising the purchased call with the lower strike price. As a trade-off for the hedge it offers, this written call limits the potential maximum profit for the strategy.

Risk vs. Reward

  • Upside Maximum Profit: Limited Difference Between Strike Prices - Net Debit Paid
  • Maximum Loss: Limited Net Debit Paid

A bull call spread tends to be profitable when the underlying stock increases in price. It can be established in one transaction, but always at a debit (net cash outflow). The call with the lower strike price will always be purchased at a price greater than the offsetting premium received from writing the call with the higher strike price. Maximum loss for this spread will generally occur as the underlying stock price declines below the lower strike price. If both options expire out-of-the-money with no value, the entire net debit paid for the spread will be lost.

The maximum profit for this spread will generally occur as the underlying stock price rises above the higher strike price, and both options expire in-the-money. The investor can exercise the long call, buy stock at its lower strike price, and sell that stock at the written call's higher strike price if assigned an exercise notice. This will be the case no matter how high the underlying stock has risen in price. If the underlying stock price is in between the strike prices when the calls expire, the long call will be in-the-money and worth its intrinsic value. The written call will be out-of-the-money, and have no value.

Break-Even-Point (BEP)?

  • BEP: Strike Price of Purchased Call + Net Debit Paid

Volatility

  • If Volatility Increases: Effect Varies If Volatility Decreases: Effect Varies

The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value portion of the options' premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.

Time Decay

  • Passage of Time: Effect Varies

The effect of time decay on this strategy varies with the underlying stock's price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the lower strike price of the long call, losses generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the written call, profits generally increase at a faster rate as time passes.

Alternatives before expiration

A bull call spread purchased as a unit for a net debit in one transaction can be sold as a unit in one transaction in the options marketplace for a credit, if it has value. This is generally the manner in which investors close out a spread before its options expire, in order to cut a loss or realize profit.

Alternatives at expiration

If both options have value, investors will generally close out a spread in the marketplace as the options expire. This will be less expensive than incurring the commissions and transaction costs from a transfer of stock resulting from either an exercise of and/or an assignment on the calls. If only the purchased call is in-the-money as it expires, the investor can either sell it in the marketplace if it has value or exercise the call and purchase an equivalent number of shares. In either of these cases, the transaction(s) must occur before the close of the market on the options' last trading day.

Options Strategies: Bull Put Spread

Establishing a bull put spread involves the writing of a put option on a particular underlying stock, while simultaneously purchasing a put option on the same underlying stock with the same expiration month, at a lower strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a "vertical spread": a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bull put spread, as any spread, can be executed as a"unit" in one single transaction, not as separate buy and sell transactions. For this bullish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.

Market Opinion: Stagnant to Moderately Bullish

When to Use

Stagnant, Moderately Bullish An investor often employs the bull put spread to capture a credit in a stagnant or moderately bullish market environment.

Risk Reduction An investor will also turn to this spread when there is discomfort with either selling the equity short or writing a naked option

Benefit

The bull put spread can be considered a hedged strategy. The price paid for the put with the lower strike price acts to limit the risk in the trade. Simply selling put carries a risk down to an equity price of zero.

On the other hand, the long put with the lower strike price caps or hedges the financial risk of the written put with the lower strike price. If the investor is assigned an exercise notice on the written put and must buy an equivalent number of underlying shares at the strike price, those shares can be sold at a predetermined price by exercising the purchased put with the lower strike price. As a trade-off for the hedge it offers, this written put limits the potential maximum profit for the strategy.

Risk vs. Reward

  • Upside Maximum Profit: Limited Net credit received
  • Maximum Loss: Limited Difference in strike prices-credit

A bull put spread reaches maximum profit when the underlying security is at or above the strike price of the short put position. It can be established in one transaction, but always with a credit. The put being sold with the higher strike price will always have a premium higher than the put being purchased with the lower strike price. Maximum loss for this spread will generally occur as the underlying stock price declines below the lower strike price.

The maximum profit for this spread will generally occur as the underlying stock price rises above the higher strike price, and both options expire out-of-the-money.

Break-Even-Point (BEP)?

  • BEP: Higher Strike Price of Sold Put-Credit

Volatility

  • If Volatility Increases: Effect Varies If Volatility Decreases: Effect Varies

The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value portion of the options' premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.

Time Decay

  • Passage of Time: Effect Varies

The effect of time decay on this strategy varies with the underlying stock's price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the higher strike price of the short put, gains generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the lower strike price of the long put, losses generally increase at a faster rate as time passes.

Alternatives before expiration

A bull put spread purchased as a unit for a net credit in one transaction can be sold as a unit in one transaction in the options marketplace for a debit. This is generally the manner in which investors close out a spread before its options expire, in order to cut a loss or realize profit.

Alternatives at expiration

If one or both options expire in of the money, investors will generally close out a spread in the marketplace as the options expire. This will be less expensive than incurring the commissions and transaction costs from a transfer of stock resulting from either an exercise of and/or an assignment on the puts. If only the written put is in-the-money as it expires, the investor can either sell it in the marketplace if it has value or get exercised the put and be required to purchase an equivalent number of shares. In either of these cases, the transaction(s) must occur before the close of the market on the options' last trading day.

Options Strategies: Bear Call Spread

Establishing a bear call spread involves the writing of a call option on a particular underlying stock, while simultaneously purchasing a call option on the same underlying stock with the same expiration month, at a higher strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a "vertical spread": a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bear call spread, as any spread, can be executed as a"unit" in one single transaction, not as separate buy and sell transactions. For this bearish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.

Market Opinion: Stagnant to Moderately Bearish

When to Use

Stagnant, Moderately Bullish An investor often employs the bear call spread to capture a credit in a stagnant or moderately bearish market environment.

Risk Reduction An investor will also turn to this spread when there is discomfort with either selling the equity short or writing a naked option

Benefit

The bear call spread can be considered a hedged strategy. The price paid for the call with the higher strike price acts to limit the risk in the trade. Simply selling a call carries an unlimited risk as the price of a stock can rise to any level. On the other hand, the long call with the higher strike price caps or hedges the financial risk of the written call with the lower strike price. If the investor is assigned an exercise notice on the written call and must sell an equivalent number of underlying shares at the strike price, those shares can be purchased at a predetermined price by exercising the purchased call with the higher strike price. As a trade-off for the hedge it offers, this written call limits the potential maximum profit for the strategy.

Risk vs. Reward

  • Upside Maximum Profit: Limited Net credit received
  • Maximum Loss: Limited Difference in strike prices-credit

A bear call spread reaches maximum profit when the underlying security is at or below the strike price of the short call position. It can be established in one transaction, but always with a credit. The call being sold with the lower strike price will always have a premium higher than the call being purchased with the higher strike price. Maximum loss for this spread will generally occur as the underlying stock price goes above the higher strike price.

The maximum profit for this spread will generally occur as the underlying stock price stays at or below the lower strike price, and both options expire out-of-the-money.

Break-Even-Point (BEP)?

  • BEP: Price of the short call+credit

Volatility

  • If Volatility Increases: Effect Varies If Volatility Decreases: Effect Varies

The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value portion of the options' premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.

Time Decay

  • Passage of Time: Effect Varies

The effect of time decay on this strategy varies with the underlying stock's price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the lower strike price of the short call, gains generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the long call, losses generally increase at a faster rate as time passes.

Alternatives before expiration

A bear call spread purchased as a unit for a net credit in one transaction can be sold as a unit in one transaction in the options marketplace for a debit. This is generally the manner in which investors close out a spread before its options expire, in order to cut a loss or realize profit.

Alternatives at expiration

If one or both options expire in of the money, investors will generally close out a spread in the marketplace as the options expire. This will be less expensive than incurring the commissions and transaction costs from a transfer of stock resulting from either an exercise of and/or an assignment on the calls. If only the written call is in-the-money as it expires, the investor can either sell it in the marketplace if it has value or get exercised the call and be required to purchase an equivalent number of shares. In either of these cases, the transaction(s) must occur before the close of the market on the options' last trading day.

Options Strategies: Long Straddle

The long straddle is simply the simultaneous purchase of a long call and a long put on the same underlying security with both options having the same expiration and same strike price. Because the position includes both a long call and a long put, the investor in a straddle should have a complete understanding of the risks and rewards associated with both long calls and long puts.

**Since the straddle involves two trades, a commission charge is likely for the purchase (and any subsequent sale) of each position -- one commission for the call and one commission for the put.

Market Opinion

Increasing volatility and large price swings in the underlying security. Potentially profit from a big move, either up or down, in the underlying price during the life of the options.

When to Use

Purchasing only long calls or only long puts is primarily a directional strategy. The long straddle however, consisting of both long calls and long puts is not a directional strategy, rather it is one where the investor feels large price swings are forthcoming but is unsure of the direction. This strategy may prove beneficial when the investor feels large price movement, either up or down, is imminent but is uncertain of the direction.

An instance of when a straddle may be considered is when the investor believes there is news forthcoming. An example may be when one is anticipating news regarding a drug in trials from a biotechnology company. The investor feels the news surrounding the drug will introduce large price swings in the underlying but is unsure of whether this news will have a positive or negative impact on the price. If the news is positive, this may positively impact the price of the security. If the news is disappointing, the stock could decline considerably. The risk is the stock remaining at the strike price of the straddle until expiration.

Benefit

A long straddle benefits when the price of the underlying moves above or below the break even points. If a large price movement occurs outside of this range, significant profits can be realized. If an increase in the implied volatility of the options outpaces time value erosion, likewise the position could realize a profit.

Risk vs. Reward

  • Maximum Profit: Theoretically unlimited to the upside; limited profits on the down side as the stock can only decline to zero.
  • Maximum Loss: Limited and predetermined, but potentially significant, equal to the sum of the two premiums paid (call premium plus put premium). Maximum loss occurs should the underlying price equal the strike price of the options at expiration.
  • Upside Profit at Expiration: (Stock Price at expiration - total premium paid) - strike price. Assuming Stock Price above BEP at expiration.
  • Downside Profit at Expiration: Strike price - (Stock price at expiration + total premium paid). Assuming stock price is below BEP at expiration.

The maximum profit on the upside is theoretically unlimited as there is no theoretical limit on how high a stock price can rise. The maximum downside profit is limited by the stock's potential decrease to no less than zero. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premiums initially paid for the straddle. Whatever your motivation for purchasing the straddle is, weigh the potential reward against the potential loss of the entire premium paid.

Break-Even-Point (BEP)?

  • BEP: Two break-even prices:

Strike Price + sum of call premium and put premium Strike price - sum of call premium and put premium

Volatility

  • If Volatility Increases: Positive Effect If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" when paying for the options, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls.

Alternatives before expiration

At any given time before expiration, assuming the options still have time value left, an investor could close both options or close out one "leg" of the overall position. One could potentially close out the call side or the put side and then simply maintain just a long call or long put position - this changes the profile of the straddle into just that of a long call or long put. For example if the underlying has increased in value significantly and the investor has now turned bearish on the underlying, selling the call and continuing to hold the put would be one choice to consider. They could "take profits" on the call portion of the straddle and after selling to close the call, would merely have a long put position.

Alternatives at expiration

By expiration investors holding a straddle may elect to sell the options back to the marketplace - possibly the call or put that hopefully has intrinsic value, before the end of trading on the option's last trading day. An investor could also elect to exercise the call or the put (assuming the stock’s price is not equal to the strike price) and subsequently maintain a long stock position (a call exercise) or a short stock position (a put exercise). This would assume that the investor was not already long or short the underlying. These choices should be discussed with your financial advisor.

Options Strategies: Long Strangle

The long strangle is simply the simultaneous purchase of a long call and a long put on the same underlying security with both options having the same expiration but where the put strike price is lower than the call strike price. Because the position includes both a long call and a long put, the investor using a long strangle should have a complete understanding of the risks and rewards associated with both long calls and long puts.

**Since the strangle involves two trades, a commission charge is likely for the purchase (and any subsequent sale) of each position; one commission for the call and one commission for the put and commission charges may significantly impact the breakeven and the potential profit/loss of the strategy.

Comparable Strategy

The long strangle is similar to the long straddle. However, while the straddle uses the same strike price for the call and the put, the strangle uses different strikes. In the case of the strangle, the put strike is below the call strike. As a result, whereas the straddle expires worthless only if the stock price equals the strike price, the long strangle expires worthless if the underlying price is at or between the strike prices at expiration. The strangle will generally provide more leverage when compared to a straddle as it is normally less expensive to purchase a strangle than a straddle.

Market Opinion

Increasing volatility and extremely large price swings in the underlying security. Potentially profit from a large move, either up or down, in the underlying price during the life of the options.

When to Use

Purchasing only long calls or only long puts is primarily a directional strategy. The long strangle however, consisting of both long calls and long puts is a not a directional strategy, rather one where the investor feels extremely large price swings are forthcoming but is unsure of the direction. This strategy may prove beneficial when the investor feels large price movement, either up or down, is about to happen but uncertain of the direction.

An instance of when a strangle may be considered is when an earnings announcement is forthcoming. The investor feels the projected announcement will introduce large price swings in the underlying. If the earnings announcement and future outlook is positive, this may positively impact the price of the security. If the earning announcement and outlook is negative, or fails to impress investors, the stock could decline considerably. The risk is the stock remains stable or between the strike price of the call and strike price of the put until expiration. Another risk is that the stock's move does not produce a corresponding option price increase that is enough to cover the two premiums paid for the position. Declining implied volatility will also negatively impact this strategy.

Benefit

A long strangle benefits when the price of the underlying moves above or below the break even points. If a large price movement occurs outside of this range, significant profits can be realized. If an increase in the implied volatility of the options outpaces time value erosion, likewise the position could realize a profit.

Risk vs. Reward

  • Maximum Profit: Theoretically unlimited to the upside; limited profits on the down side as the stock can only decline to zero.
  • Maximum Loss: Limited and predetermined, but potentially significant, equal to the sum of the two premiums paid (call premium plus put premium). Maximum loss occurs if the underlying price is between the strike price of the call and put options at expiration.
  • Upside Profit at Expiration: (Stock Price at expiration - total premium paid) - call strike price. Assuming Stock Price above BEP at expiration.
  • Downside Profit at Expiration: Put strike price - (Stock price at expiration + total premium paid). Assuming stock price is below BEP at expiration.

The maximum profit on the upside is theoretically unlimited as there is no theoretical limit on how high a stock price can rise. The maximum downside profit is limited by the stock's potential decrease to no less than zero. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premiums initially paid for the strangle. Whatever your motivation for purchasing the strangle is, weigh the potential reward against the potential loss of the entire premium paid.

Break-Even-Point (BEP)?

  • BEP: Two break-even prices:

Call strike price + sum of call premium and put premium Put strike price - sum of call premium and put premium

Volatility

  • If Volatility Increases: Positive Effect If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Time Decay

  • Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" when paying for the options, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration. A market observer will notice that time decay for puts occurs at a slightly slower rate than with calls.

Alternatives before expiration

At any given time before expiration, assuming the options still have time value left, an investor could close both options or close out one "leg" of the overall position. One could potentially close out the call side or the put side and then simply maintain just a long call or long put position - this would change the profile of the strangle into only that of a long call or long put. For example if the underlying has increased in value significantly and the investor has now turned bearish on the underlying, selling the call and continuing to hold the put would be one choice to consider. They could "take profits" on the call portion of the strangle and after selling to close the call, would merely have a long put position.

Alternatives at expiration

By expiration, investors holding a strangle may elect to sell the options back to the marketplace - possibly the call or put that hopefully has intrinsic value, before the end of trading on the option's last trading day. An investor could also elect to exercise the call or the put (assuming the stock’s price below the put strike or above the call strike) and subsequently maintain a long stock position (a call exercise) or a short stock position (a put exercise). This would assume that the investor was not already long or short the underlying. These choices should be discussed with your financial advisor.

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