A credit spread involves a purchase of one option and a sale of another option in the same class and expiration month but different strike prices. Investors receive a net credit for entering the position and want the spreads to narrow or expire worthless for profit.
For example, if stock XYZ is currently trading at $100 and we sell the $120 strike price call for $3 and then we buy the $125 strike price call for $2.25 we collect a net of $.75. As long as the stock stays below $120 until expiration the $.75 is ours to keep. Being there is a time limit on the position, with each passing day the position decays away, now we can always buy it back or let it decay to zero.
We figure our break-even by adding the profit to the bottom strike price for calls and to top strike price for puts, in this call spread example our break-even is $120.75. If the stock stays under $120.75 by expiration we win, if it goes over that price we lose.
Being that each option contract converts into 100 shares, if we win then multiply the credit we received ($.75) by 100 for a net profit of $75. For every dollar the price of the stock goes over our break-even we lose $100 up until our higher strike price that protects us, so in this example, we risk a max loss of $425.
At OptionStrategiesInsider.com we never let our trades go into the money and risk max loss. We only sell options that have a very low probability of ever going into the money and we adjust and manage our trades once they become too risky.
The iron condor is a favorite among many home option traders. It works by putting on an out of the money call spread and a put spread in the same class together. This way you can receive a larger credit and at the same time, you don’t decrease your buying power because you're guaranteed to win at least one side of the trade.
Iron condors are great in sideways markets, but do carry more risk as a swift move in either direction can be problematic. If the stock breaks our range an adjustment is necessary to ensure we win.
The butterfly spread is a neutral strategy that is a combination of a bull spread and a bear spread. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a butterfly spread and it can be constructed using calls or puts.
At OptionStrategiesInsider.com we use the long call butterfly spread. We combine two short calls at a middle strike, and one long call at a lower and upper strike creating a long call butterfly. The upper and lower strikes, called the wings, must both be equidistant from the middle strike, called the body, and all the options must have the same expiration date.
What we want is for the options to pin at the middle strike prices, this way we keep the credit for the body, we lose the credit for the upper wing, and we win on the lower wing.
Covered Call (Buy-Write)
At OptionStrateigesInsider.com we do not use this strategy often as it comes with increased risk. The covered call is when an investor holds a long position in the stock and sells (writes) call options on that same stock in an attempt to generate increased income from the investment. Typically I like to do this when stocks get crushed, we can take a position in the stock once it falls to an attractive price and at the same time sell the out of the money call option to take advantage of the increased volatility without the risk of a big bounce.
If the stock trades down a little, stays the same, or trades up we win. We would only be vulnerable to a substantial move down.