Volatile Limited Risk Option Plays

Long Straddle / Long Strangle

• Long call and long put at same strike (straddle) or different strikes (strangle) at same expiration
• Unlimited profit potential to upside and downside
• Loss limited to the cost of the straddle or strangle
• Break-even points are the strike plus and minus the value of the straddle, or high strike plus and lower strike minus the value of the strangle
• The definitive position for volatile markets
• Time decay (theta) is your enemy
• The technique called "gamma scalping" can be used with straddles and strangles to offset time decay

Back Spreads

• Long more options than short options
• Unlimited profit potential with limited risk
• This position has net long options, and is long volatility (vega)
• Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)
• Sluggish stock price movement and time are your enemies

Range Bound Option Plays

Trading Range Limited Risk

Long At-The-Money Butterfly/Condor

• A condor is like a "stretched out" butterfly with two different middle strikes rather than just one
• Can be a relatively inexpensive option strategy that has limited risk and limited profit potential
• The closer a butterfly is to expiration, the more it will react to changes in the stock price
• A strategy used by professional traders for years because of its protective characteristics
• For a long butterfly, you want the stock to stay near the middle strike
• Time decay (positive theta) is your friend

Long At-The-Money Time Spread

• Long back month call (put) and short front month call (put) with the same strike price
• Maximum loss is limited to the price of the time spread, but can be greater in certain index options
• This spread works best if the stock price stays right at the strike price
• Implied volatility can change at different rates in different expirations
• The position becomes more sensitive to changes in the stock price as expiration nears

Bearish Option Plays

Bearish Limited Risk Long Put Easy to execute and manage The delta of a put tells you your exposure to changes in the stock The delta of a put will change with stock price movement and the passage of time Don't forget about time decay (negative theta) Keep in mind that volatility of the underlying and fluctuations in implied volatility (supply and demand for premium) affect option prices Put Back Spread Long more lower strike puts and short higher strike put at same expiration Like a long put, it has unlimited downside profit potential with limited risk At expiration, the stock needs to be significantly below the long strike to make money This position has net long options, and is usually long volatility (vega) Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it) The potential liability is the difference between the strikes

Bullish Option Plays

Bullish Limited Risk

Long call

• Easy to execute and manage
• The delta of a call tells you your exposure to changes in the stock
• The delta of a call will change with stock price movement and the passage of time
• Don't forget about time decay (negative theta)
• Keep in mind that volatility of the underlying and fluctuations in implied volatility (supply and demand for premium) affect option prices

Call Back Spread

• Long more higher strike calls and short lower strike call at same expiration
• Like a long call, it has unlimited upside profit potential with limited risk
• At expiration, the stock needs to be significantly above the long strike to make money
• This position has net long options, and is usually long volatility (vega)
• Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)
• The potential liability is the difference between the strikes

Time Spreads & Diagonals

Long Call Time Spread:
Short 1 XYZ Sep 50 call @ $2.00, Long 1 XYZ Dec 50 call @ $5.00
Cost	$300 Debit
Maximum Loss:	$300
Maximum Profit:	Depends on value of Dec 50 call at time of Sep expiration
Short Call Time Spread
Long 1 XYZ Sep 50 call @ $2.00, Short 1 XYZ Dec 50 call @ $5.00
Cost	$300 Credit
Maximum Loss:	Depends on value of Dec 50 call at time of Sep expiration
Maximum Profit:	$300
Long Put Time Spread
Short 1 XYZ Sep 50 put @ $1.00, Long 1 XYZ Dec 50 put @ $3.00
Cost	$200 Debit
Maximum Loss:	$200
Maximum Profit:
Short Put Time Spread
Long 1 XYZ Sep 50 put @ $1.00, Short 1 XYZ Dec 50 put @ $3.00
Cost	$200 Credit
Maximum Loss:	Depends on value of Dec 50 put at time of Sep expiration
Maximum Profit:	$200

Explanation and Application

Time spreads are so called because they are positions with options in two different expiration months, with the options being either both calls or both puts. Time spreads involve buying an option in one expiration month and selling another option in a different expiration month but with the same strike as the first option. Specifically; a long call time spread is selling a call in a front month at a certain strike, and buying a call in a deferred month at the same strike. A put time spread is selling a put in a front month at a certain strike, and buying a put in a deferred month at the same strike. A short call time spread or put time spread is simply the reverse of the long time spread: long front month and short deferred month. In time spreads, one option in the position expires before the other. You have to keep this in mind because it does present certain risks and necessary adjustments that other types of positions might not.

Time spreads, whether they are call time spreads or put time spreads, maximize their value when the stock is at the strike price of the options, and the front month option is expiring. Time spreads have their minimum value when the stock is very far away from the strike price of the options. If you buy a time spread you want the stock price to be at the strike price at expiration. If you sell a time spread you want the stock price to be as far away as possible from the strike price at expiration.

Butterflies & Wingspreads

Long Call Butterfly
Long 1 XYZ Sep 50 call @ $2.00, Short 2 XYZ Sep 55 calls @ $1.00, Long 1 XYZ Sep 60 call @ $.50
Total Cost	Option premium paid, $50
Maximum Loss	Option premium paid, $50
Maximum Profit	Dollar value of difference between outside and middle strike prices minus premium paid, $450
Short Call Butterfly:
Short 1 XYZ Sep 50 call @ $2.00, Long 2 XYZ Sep 55 calls @ $1.00, Short 1 XYZ Sep 60 call @ $.50
Total Credit Received	Net option premium received, $50
Maximum Loss	Dollar value of difference between outside and middle strike prices minus credit received, $450
Maximum Profit	Net option premium received, $50
Long Put Butterfly:
Long 1 XYZ Sep 30 put @ $.25, Short 2 XYZ Sep 35 puts @ $.50, Long 1 XYZ Sep 40 put @ $1.00
Total Cost	Option premium paid, $25
Maximum Loss	Option premium paid, $25
Maximum Profit	Dollar value of difference between outside and middle strike prices minus premium paid, $475
Short Put Butterfly
Short 1 XYZ Sep 30 put @ $.25, Long 2 XYZ Sep 35 puts @ $.50, Short 1 XYZ Sep 40 put @ $1.00
Total Credit Received	Net option premium received, $25
Maximum Loss	Dollar value of difference between outside and middle strike prices minus credit received, $475
Maximum Profit	Net option premium received, $25

Explanation and Application

Butterflies, condors and "wingspreads" are so-called because with sufficient -- no, make that CONSIDERABLE imagination, their expiration date risk profiles look like something that could fly. That, and anything that can add a bit of color to the otherwise dreary world of option trading is welcome. When talking about butterflies et al., you'll hear self-proclaimed experts speak of options as "body" and "wings". The "body" refers to options with strikes in between the two exoskeletal outermost strikes. The "wings" refer to options at the diaphanous outermost strikes. We use the term "wingspreads" to identify option positions such as "condors", "pterodactyls" and "albatrosses", which look like butterflies that have been stretched out. Rather than come up with a myriad of names to identify these spreads, we use "wingspreads" because they all have similar risk/reward characteristics and sensitivities, and those flying creatures are much more threatening than butterflies.

The risks and potential rewards of butterflies and wingspreads are limited. If you buy a butterfly, the most you can lose is the amount you paid for it. The most you can make is the difference between the "body" strike and a "wing" strike minus the amount you paid for it. If you sell a butterfly, the loss and profit are the inverse of buying a butterfly.

Ratio & Back Spreads

Call Back Spread
Short 1 XYZ Sep 50 call @ $2.00, Long 2 XYZ Sep 60 calls @ $0.75
Cost	$50 Credit
Maximum Loss	$950
Maximum Profit	Unlimited
Call Ratio Spread
Long 1 XYZ Sep 50 call @ $2.00, Short 2 XYZ Sep 60 calls @ $0.75
Cost	$50 Debit
Maximum Loss	Unlimited
Maximum Profit	$950
Put Back Spread
Short 1 XYZ Sep 50 put @ $1.00, Long 2 XYZ Sep 40 puts @ $0.50
Cost	$0 Even Money
Maximum Loss	$1000
Maximum Profit	Unlimited
Put Ratio Spread:
Long 1 XYZ Sep 50 put @ $1.00, Short 2 XYZ Sep 40 puts @ $0.50
Cost	$0 Even Money
Maximum Loss	Unlimited
Maximum Profit	$1000

Explanation and Application

Back spreads and ratio spreads are simply the mirror image of each other. Back spreads and ratio spreads are comprised of either both calls or both puts at two different strike prices in the same expiration month. If the spread has more long contracts than short contracts, it is a Back Spread. If there are more short contracts, it is a Ratio Spread. Any ratio of long to short options is possible, but to keep it simple we will deal mainly with 1 by 2s in this article, i.e. long 1 option and short 2 option ratio spreads, and short 1 option and long 2 option back spreads. When naming this type of spread, the lower strike is generally stated first, whether it is long or short, so, it's the Sep 50/60 call back spread or ratio spread, and the 40/50 put back spread or ratio spread.

Back spreads and ratio spreads can be executed for debits (you pay money) or credits (you receive money) or Even Money when there is no debit or credit. This occurs because the amount you pay for the long options in the spread is sometimes less than, equal to, or more than the amount you receive for the short options in the spread. This can be a bit confusing at times, because you might be a credit bid for a back spread or ratio spread.