Option Trading Strategies
This page was created to give prospective members
a better feel for the option trades we make.
What strategy we choose depends on what the
market is doing. If the market is flat and not
moving much we do certain types of trades more,
and if the market is flying in one direction
either up or down, we concentrate more on other
types of trades.
Volatility is an option trader's friend and
nemesis. High volatility is great because it
raises the prices of all options. As sellers,
this means options are pricier and the seller
gets paid more when he sells them than under
normal conditions. But high volatility can also
hurt us because the market can move quickly.
Here are the option trading strategies we use
and a short decription of them.
The credit spread is one of our
favorite option strategies. This is a trade which
results in a credit (money given to you at the
beginning of the trade). It consists of two different
You buy an out of the money option
at a certain strike price and then you sell an
out of the money option at a different strike
price of the same month.
For example, if ABC stock is selling
at $50. You sell the $75 January Call option for
$2. Then you buy the $80 January Call option for
$1.50. You get a credit of 50 cents. As long as
ABC stays below $75 at expiration you get to keep
the credit. As time goes on the options will decay
in value. This strategy allows you to win if ABC
goes down, stays where it is, or goes up until
$75.50. You start to lose money above $75.50.
Since each option is for 100 shares,
the maximum potential gain on the above trade
would be $50. (50 cents x 100 shares). The maximum
loss would be $450. (Difference in strikes minus
the credit: 80-75-.5) The return on investment
would be 11.11% I like to place credit spread
close to expiration so this return for would for
a one or two month time frame.
Buying the second option does two
1. If protects you from a large loss if ABC shoots
2. It allows you to do the trade with less margin.
So even though you have to pay for
the second option, it is a conservative strategy
to employ it.
You can also do credit spreads with
Put options if you think a stock is going up.
Which option strike you decide to
sell depends on how aggressive you want to be.
Our style is conservative so we choose options
that have a very low probability of expiring with
any value. If you use this strategy with At the
Money or In the Money options you can make a lot
more money, but have a higher risk of loss.
Condor Option Trading
Another of our favorite option strategies
is the Iron Condor.
Condor is simply two credit spreads, calls
and puts, used together. This way you get a larger
credit. Most stocks stay within a range. And using
statistics we can tell with a high degree of confidence
exactly what that range will be. We then sell
options above and below this range. As long as
the stock stays in the range, we win.
If the stock threatens to break
our range, we have to adjust our range by adjusting
the trade to account for the movement.
If you subscribe to my Free Options
Course, I will show you exactly how we put on
an Iron Condor trade, a real trade that we did,
and the adjustments that we made to the trade
when it got into trouble.
For more details click here: Iron
The butterfly is a neutral position
that is a combination of a bull spread and a bear
Let's look at an example using calls.
ABC price: 60
July 50 Call: 12
July 60 Call 6
July 70 Call 3
Buy 1 July 50 Call $1,200 Debit
Sell 2 July 60 Call $1,200 Credit
Buy 1 July 70 Call $300 Debit
$300 Debit to place the trade
Our maximum loss is our debit of
The Maximum potential gain is the difference between
strikes minus the debit (10-3=7)
So our Max gain is $700.
Results of butterfly spread at expiration
|Price at Expiration
||July 50 Profit
||July 60 Profit
||July 70 profit
As you can see our breakeven points
are 53 and 67. As long as ABC stays between those
strikes the trade will be a winner.
While the covered call is considered
a conservative option strategy it can be very
Basically you buy 100 shares of stock and you
write a call against that stock.
So for example, you buy 100 shares
of ABC at 100 and you sell the 100 Call for 2.00.
At expiration if ABC is above 100, your call will
be exercised and they will take your 100 shares.
But you get to keep the 2.00.
Writing calls against stock you
already own and want to keep long term is a neat
way to make some extra money for holding the stock.
Where you can get into trouble is
when the stock drops in price. If you want to
hold it, do so. But if you were in for a quick
trade, you are in trouble. If that is a risk,
you can do a covered call that is already in the
money. So buy ABC at 100 and sell the 90 Call.
We do not use this technique much.
But it comes in handy in times of very high volatility.
When volatility is high, options are more expensive
and so the premiums we get by selling options
are larger than normal. We can use covered calls
to take advantage of this volatility.
Here's a real trade that we did
on November 26, 2008.
Stock Symbol: C
Buy 200 shares at 7.00
Sell 2 Dec 5 Calls at 2.31 for a Debit of 4.69
I chose to illustrate the trade
with 200 shares, but members are free to trade
as much or as little as they want.
In this trade we paid $7 each for
200 shares = $1,400. We then got a credit of $462
for selling 2 calls that were set to expire in
25 days on December 20. Notice that we sold In
the Money Calls. So if C is above $5 on expiration
day we will get called and our stock will be taken
away from us which results in a maximum gain.
We stand to make 31 cents per share
or $62 max. That is a 6.6% return in only 25 days.
If you use margin the return is 13.2%.
On expiration day C was at 7.02.
Our stock got called away and we made the max
on the trade..
The Calendar (AKA: Time Spread)
is a spread that is a relatively cheap trade but
has a large profit potential. It is created by
selling one option and buying a more distant option
with the same strike price. When we use it as
a neutral trade, we benefit from the time decay
because the near term option will decay and lose
value faster than the farther out option that
we bought. When enough decay has occurred we exit
The risk in a Calendar is the debit
required to put on the trade.
Check out this link for more on
Diagonal Option Trading Strategy
A Double Diagonal is two diagonals,
Puts and Calls put together. First, let's discuss
the regular diagonal trade. The diagonal spread
is created by buying a longer term call at a higher
strike price and selling a near term call at a
lower strike price.
So if ABC was at 100, we would sell
the January 110 Call and Buy the February 120
Call. In this case we want ABC to stay below 100
at expiration in January.
To make it a Double, you do the
same on the Put side.
So we would sell the January 90 Put and buy the
February 80 Put.
This gives us a range of 110-90
that ABC can play in. If it stays in that range
we make our max profit. If it gets out, we need
to make adjustments. The Double Diagonal is a
good trade because with adjustments you can still
win even if the stock goes well out of the range.