Equity Option Strategies - Buying Calls

Equity Option Strategies - Buying Calls
Who Should Consider Buying Equity Calls?

 An investor who is very bullish on a particular stock and wants to profit from a rise in
its price.
 An investor who would like to take advantage of the leverage that options can
provide, and with a limited dollar risk.
 An investor who anticipates a rise in value of a particular stock but does not want to
commit all of the capital needed to purchase shares.
Buying an equity call is one of the simplest and most popular strategies used by option
investors. It allows an investor the opportunity to profit from an upward move in the price of
the underlying stock, while having less capital at risk than with the outright purchase of an
equivalent number of underlying shares, usually 100 shares per call contract.
Definition
Buying an equity call gives the owner the right, but not the obligation, to buy 100 shares of
underlying stock at a specified price (the strike price) at any time before a specific time (the
expiration date). This is a bullish strategy because the value of the call tends to increase as the
price of the underlying stock rises, and this gain will increasingly reflect a rise in the value of
the underlying stock when the market price moves above the option's strike price.
The profit potential for the long call is unlimited as the underlying stock continues to rise.
The financial risk is limited to the total premium paid for the option, no matter how low the
underlying stock declines in price. The break-even point is an underlying stock price equal to
the call's strike price plus the premium paid for the contract. As with any long option, an
increase in volatility has a positive financial effect on the long call strategy while decreasing
volatility has a negative effect. Time decay has a negative effect.
Buying Calls Example
Participate in Upward Stock Price Movement With
Limited Downside Risk
Please note: Commission, dividends, margins, taxes and other transaction charges have not
been included in the following examples. However, these costs can have a significant effect
on expected returns and should be considered. Because of the importance of tax
considerations to all options transactions, the investor considering options should consult
with his/her tax advisor as to how taxes affect the outcome of contemplated options
transactions.
Example
ZYX is trading at $44.25, so 100 shares of stock would cost a total of $4,425. However, an
investor could instead purchase one six-month ZYX 45 call, which represents the right to
purchase 100 underlying ZYX shares at $45 per share, for a quoted price of $3.25. The total
cost for the call would be: $3.25 x 100 contract multiplier = $325, a fraction of the total stock
purchase price. Instead of committing $4,425 on the purchase of 100 ZYX shares, spending
only $325 for the purchase of one call would leave a balance of $4,100 that could then be
invested in short-term, interest-bearing instruments.
By purchasing the call the investor is saying that by expiration he anticipates ZYX to have
risen above the break-even point: $45 strike price (at which price ZYX can be purchased no
matter how high it has risen) + $3.25 (the option premium paid), or a ZYX share price of
$48.25. The investor's profit potential is unlimited as ZYX stock price continues to rise above
$48.25. The risk for the call purchase is limited entirely to the total premium paid for the
contract, or $325, no matter how low ZYX stock price declines.
Before expiration, if the call purchase becomes profitable the investor is free to sell the option
in the marketplace to realize this gain. On the other hand, if the investor's bullish outlook
proves incorrect and ZYX declines in price, the call might be sold to realize a loss less than
the maximum.
Consider three possible scenarios at expiration:
 ZYX closes above the break-even point

 ZYX closes between the strike price and the break-even point
 ZYX closes below the strike price
Close Above Break-Even Point

ZYX is above break-even point of $48.25 at expiration
If ZYX closes above the break-even point of $48.25 at expiration, at $51 per share for
instance, the option will be in-the-money and worth its intrinsic value (difference between the
strike price and stock price):
$51.00 ZYX stock price

-$45.00 call strike price
$6.00 intrinsic value
If you sell the ZYX 45 call for its intrinsic value of $6 then you would see a profit:
$6.00 intrinsic value received at call's sale

$3.25 premium initially paid for call
$2.75 profit
This profit of $2.75 ($275 total) represents a return on an initial investment of $3.25 premium
paid for the call ($325 total) of approximately 84.6% over the 6-month life of the call
contract.
The call could also be exercised, and 100 shares of ZYX purchased at the contract's strike
price of $45 per share plus the $3.25 call premium paid, or a net price of $48.25. The stock
could either be sold in the marketplace or held in anticipation of continued profits on the
upside.
Instead of purchasing the call, had the stock been purchased outright at $44.25 per share and
increased in price to $51 at option expiration, it would then be worth a total of $5,100. The
result is a 15.25% return over the initial stock investment of $4,425 versus an 84.6% return
for the option investor.
Close Between Strike and Break-Even

ZYX is between $45 and $48.25 at expiration
With ZYX exactly at the strike price of $45 at expiration, the $45 call would be exactly at-
the-money and have no value. With ZYX at the break-even point of $48.25 at expiration the
call's intrinsic value would be $3.25, or its initial cost. With ZYX closing between $45 and
$48.25 at expiration, the $45 call will be in-the-money and have an intrinsic value of less than
its initial cost. In this case the option could be sold to recoup some of its original purchase
price resulting in a partial loss for the position.
For example, ZYX closes at $47 at expiration. The call's intrinsic value at this point would
be:
$47.00 ZYX stock price
-$45.00 call strike price
ZYX did rise in value, but not as much as anticipated. The option that cost $3.25 is now
worth $2, so the investor can sell the call and recoup some of its initial purchase price. If the
ZYX 45 call is sold for its intrinsic value of $2 then the loss for the position would be:
$3.25 premium initially paid for call

$2.00 premium received at call's sale
$1.25 partial loss
The call could also be exercised. 100 shares of ZYX would be purchased at the contract's
strike price of $45 per share plus the $3.25 call premium paid, or a net price of $48.25 per
share. The stock could either be sold in the marketplace or held in anticipation of continued
profits on the upside.
Instead of purchasing the call, had the stock been purchased outright at $44.25 per share and
increased in price to $47 at expiration, it would then be worth a total of $4,700. The result is a
6.2% return over the initial stock investment of $4,425 versus a partial loss of $125 from an
initial investment of $325 for the option investor. However, the call buyer could have earned
interest on $4,100 not committed to the initial stock purchase, which could offset some of the
option loss.
Close Below Strike

ZYX is at or below $45 at expiration
Say ZYX stock did not move as anticipated, but instead declined and closes at $40 per share
at expiration. The ZYX call would expire out-of-the-money and with no value, so the investor
would lose the total premium of $325 initially paid for the option. This would be the limited,
maximum loss no matter how far ZYX stock had declined, and would also be realized if at
expiration ZYX closed at any point at or below the $45 strike price and the call expired out-
of-the-money.
Assume the same scenario of ZYX closing at $40 on expiration and consider an initial
purchase of 100 shares at $44.25 instead of the call. At $40 per share, the 100 shares would
have declined in value to $4,000. The stock investor would be facing an unrealized loss of
$425, and would have incurred a greater loss if ZYX stock had declined even further. The
option investor's loss, however, is limited to the $325 premium paid for the contract. The
stock investor now has two choices: sell the stock and realize this loss, or hold onto the stock
and hope for an increase in price to recoup some or all of the loss.
By purchasing the call for significantly less cash than an outright purchase of 100 ZYX
shares, the investor limited the investment capital at risk if ZYX stock did not increase in
price as anticipated. Now he still has the cash balance of his original investment capital, plus
interest if it had been invested in short-term interest bearing instruments, with which to make
another investment decision.
Buying Calls Summary

For those who are very bullish on a particular stock over the near- or long-term, and who
require a known, limited downside risk, buying a call might be an appropriate strategy to use.
Purchasing a call option usually requires a smaller initial cash investment than an outright
stock purchase, which in addition to reducing the capital at risk offers the potential of
leveraged profits if a bullish opinion proves correct. As the underlying stock continues to
increase, the long call's profit potential is theoretically unlimited, and larger returns on
investment can be seen in comparison to an outright stock purchase. On the downside, the
stock investor is exposed to a potentially significant dollar loss from a decline in share value,
while the call buyer's maximum loss is known in advance and is limited entirely to the
option's purchase price.
Today's investor has a choice of shorter-term expiration months afforded by regular equity
option contracts, longer-term expirations available with LEAPS®, as well as multiple strike
prices. So no matter an investor's anticipated target price for an underlying stock after a
bullish move, or the time frame over which this move might occur, there is most likely a call
contract that fits both his outlook and tolerance for risk.
Buy Call Strategy Worksheet

Download the "Who Should Consider Buying Calls?" Worksheet
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Equity Option Strategies - Buying Puts

3 minutes
Who Should Consider Buying Equity Puts?
 An investor who is very bearish on a particular stock and wants to profit from a
decline in its price.
 An investor who would like to take advantage of the leverage that options can
provide, and with a limited dollar risk.
 An investor who anticipates a decline in the value of a particular stock but does not
want the unlimited upside risk or the commitment of capital needed for a short sale of
underlying shares.
Buying an equity put is one of the simplest and most popular strategies used by bearish
option investors. It allows an investor the opportunity to profit from a downward move in the
price of the underlying stock while committing less capital compared to the potentially
significant initial margin requirements needed for a short sale of an equivalent number of
underlying shares, usually 100 shares per put contract. In addition, a long put holder is not
subject to margin calls with an increasing underlying stock price as is an investor with an
equivalent short stock position.
Definition
Buying an equity put gives the owner the right, but not the obligation, to sell 100 shares of
underlying stock at a specified price (the strike price) at any time before a specific time (the
expiration date). This is a bearish strategy because the value of the put tends to increase as the
price of the underlying stock declines. This gain in option value will increasingly reflect a
decline in the value of the underlying shares when the stock's market price moves below the
option's strike price.
The profit potential is significant as the underlying stock continues to decline, and is limited
only by a potential decrease in the stock's price to no less than zero. The financial risk is
limited to the total premium paid for the option, no matter how high the underlying stock
increases in price. Investors find this limited risk more attractive than the unlimited upside
risk incurred from selling 100 shares of stock short. In addition, a short seller of underlying
shares must pay any dividends distributed to shareholders while the short position is held; a
put holder does not. The break-even point is an underlying stock price equal to the put's strike
price minus the premium paid for the contract. As with any long option, an increase in
volatility has a positive financial effect on the long put strategy while decreasing volatility
has a negative effect. Time decay has a negative effect.
cboe.com
Buying Puts Example

2-3 minutes
Participate in Downward Stock Price Movement With

Limited Upside Risk
transactions.
Example
ZYX is trading at $52.00. However, instead of selling 100 shares short an investor could
purchase one six-month ZYX 50 put, which represents the right to sell 100 underlying ZYX
shares at $50 per share, for a quoted price of $3.00. The total cost for the put would be: $3.00
x 100 contract multiplier = $300. By purchasing the put the investor is saying that by
expiration he anticipates ZYX to have declined below the break-even point: $50 strike price
(at which price ZYX can be sold no matter how low it has declined) - $3.00 (the option
premium paid), or a ZYX share price of $47.00.
The investor's profit potential can be significant as ZYX stock price continues to decline
below $47.00, and is theoretically limited because a stock can decline only to zero. The risk
for the put purchase is limited entirely to the total premium paid for the contract, or $300, no
matter how high ZYX stock price might increase.
Before expiration, if the put purchase becomes profitable the investor is free to sell the option
in the marketplace to realize this gain. On the other hand, if the investor's bearish outlook
proves incorrect and ZYX increases in price, the put might be sold to realize a loss less than
the maximum.
 ZYX closes below the break-even point

 ZYX closes between the strike price and the break-even point
 ZYX closes above the strike price
 cboe.com
Close Below Break-Even Point

2 minutes
ZYX is below break-even point of $47.00 at expiration
If ZYX closes below the break-even point of $47.00 at expiration, at $43 per share for
instance, the option will be in-the-money and worth its intrinsic value (difference between
the strike price and stock price):
$50.00 put strike price

-$43.00 ZYX stock price
If you sell the ZYX 45 put for its intrinsic value of $7 then you would see a profit:
$7.00 intrinsic value received at put's sale

$3.00 premium initially paid for put
$4.00 profit
This profit of $4.00 ($400 total) represents a return on an initial investment of $3.00
premium paid for the put ($300 total) of approximately 133% over the 6-month life of the
put contract.
The put could also be exercised, and 100 shares of ZYX sold at the contract's strike price
of $50 per share less the $3.00 put premium paid, or a net price of $47. However, if those
shares aren't owned the investor would then have a position of short 100 ZYX shares after
exercise. In addition to unlimited upside stock risk, the result of this short stock position
could be a potentially significant initial margin requirement (which can vary greatly
among brokerage firms) as well as margin calls if ZYX increases in price. For this reason
many investors choose to simply sell a put that is in-the-money at expiration.
cboe.com
Close Between Strike and Break-Even

2 minutes
ZYX is between $50 and $47.00 at expiration
With ZYX exactly at the strike price of $50 at expiration, the 50 put would be exactly at-the-
money and have no value. With ZYX at the break-even point of $47.00 at expiration the put's
intrinsic value would be $3.00, or its initial cost. With ZYX closing between $50 and $47.00
at expiration, the 50 put will be in-the-money and have an intrinsic value of less than its
initial cost. In this case the option could be sold to recoup some of its original purchase price
resulting in a partial loss for the position.
For example, ZYX closes at $48 at expiration. The put's intrinsic value at this point would be:
$50.00 put strike price

-$48.00 ZYX stock price
ZYX did decline in value, but not as much as anticipated. The option that cost $3.00 is now
worth $2, so the investor can sell the put and recoup some of its initial purchase price. If the
ZYX 50 put is sold for its intrinsic value of $2 then the loss for the position would be:
$3.00 premium initially paid for put

$2.00 premium received at put’s sale
$1.00 loss
The put could also be exercised. 100 shares of ZYX would be sold at the contract's strike
price of $50 per share less the put premium paid, or a net price of $47 per share. But if those
shares aren't owned, the investor would then have a short stock position along with its
inherent margin requirements, possibility of margin calls, and unlimited upside stock price
risk.
cboe.com
Close Above Strike

1-2 minutes
ZYX is at or above $50 at expiration
Say ZYX stock did not move as anticipated, but instead increased and closes at $57 per share
at expiration. The ZYX put would expire out-of-the-money and with no value, so the investor
would lose the total premium of $300 initially paid for the option. This would be the limited,
maximum loss no matter how far ZYX stock had risen, and would also be realized if at
expiration ZYX closed at any point at or above the $50 strike price and the put expired out-
of-the-money.
Had the investor initially chosen a short sale of 100 ZYX shares as opposed to purchasing the
$50 put when ZYX was trading at a price of $52, he would also incur a loss with ZYX
trading at $57. However, the investor would have unlimited risk above this price level, and
there is no theoretical limit as to how high a stock price can increase.
cboe.com
Buying Puts Summary

2 minutes
For those who are very bearish on a particular stock over the near- or long-term, and who
require a known, limited upside risk, buying a put might be an appropriate strategy to use.
Purchasing a put option usually requires a smaller initial cash investment than the margin
requirement for a short sale of stock. In addition, there are neither margin calls, nor does a put
holder pay any dividends. This reduces the capital at risk and offers the potential of leveraged
profits if a bearish opinion proves correct. As the underlying stock continues to decrease, the
long put's profit potential is limited only by the underlying stock declining to zero, and large
returns on investment can be seen. On the upside, the investor with a short stock position is
exposed to a potentially unlimited dollar loss from an increase in share value, while the put
buyer's maximum loss is known in advance and is limited entirely to the option's purchase
price.
Today's investor has a choice of shorter-term expiration months afforded by regular equity
option contracts, longer-term expirations available with LEAPS®, as well as multiple strike
prices. So no matter an investor's anticipated target price for an underlying stock after a
bearish move, or the time frame over which this move might occur, there is most likely a put
contract that fits both his outlook and tolerance for risk.
Equity Option Strategies - Covered Calls

Who Should Consider Writing Covered Equity Calls?
 An investor who is neutral to moderately bullish on certain portfolio holdings.
 An investor willing to limit upside profit potential on a specific stock holding in
exchange for limited downside protection.
 An investor who wishes to generate income in addition to any dividends from shares
of underlying stock owned.
This strategy is one of the most basic and widely used that combines the flexibility of listed
equity options with the benefits of stock ownership. It works well for cash, margin, and
Keogh accounts or IRAs. Although this strategy may not be suitable for everyone, it can
provide a stock-owning investor limited downside stock price protection in return for limited
participation on the upside. In addition, the covered call generates income from the premium
received from the call contract's sale that can supplement any dividend income paid to
eligible underlying stockholders.
Definition
Covered call writing is either the simultaneous purchase of stock and the sale of a call option,
or the sale of a call option covered by underlying shares currently held by an investor.
Generally, one call option is written for every 100 shares of stock owned. The writer receives
cash for selling the call but will be obligated to sell the stock at the call's strike price if
assigned, thereby capping further upside stock price participation. In other words, an investor
is "paid" for agreeing to sell his holdings at a certain level (the strike price). For this reason
the covered call is considered a neutral to moderately bullish strategy. On the downside,
limited stock price protection is provided by the premium received from the call's sale.
The upside profit potential if assigned is limited to the premium received from the call's sale
plus the difference between its strike price and the stock purchase price. If assignment is not
received and the call expires out-of-the-money and with no value, the upside profit potential
is any gain in share value plus the premium received. The downside loss potential is
substantial and comes entirely from owning the underlying shares and is limited only by the
stock declining to zero. The break-even point is an underlying stock price equal to the
purchase price of the underlying shares less the premium received. As with any short option
position an increase in volatility has a negative financial effect on the covered call while
decreasing volatility has a positive effect. Time decay has a positive effect.
Covered Calls Example

How to Use Covered Calls
Let's say that an investor holds 100 previously purchased shares of stock, and has either a
neutral or slightly bullish market opinion on its price over a given period of time. A call is
selected with a strike price, usually out-of-the-money, at which the investor is comfortable
selling his shares if assigned, and that can be sold for a premium that provides downside
stock price protection that fits his tolerance for risk. The expiration month reflects the time
frame of his market opinion. If the investor is particularly bearish on this stock then he might
choose another strategy, such as a protective put, which offers more protection from a
declining share price. If particularly bullish, then he might choose to leave the stock
uncovered for the unlimited upside profit potential that shares offer.
The call could also be written at the same time underlying shares are bought, and the criteria
used in considering which call to sell would be similar. Whether the call is written on
previously purchased shares, or simultaneously with a new stock purchase, the premium
collected reduces the effective cost of the stock. The investor will also continue to collect
dividends (if any) as long as the stock is owned.
Writing a Covered Call to Generate Income and Provide

Limited Downside Protection
transactions.
Example
An investor has purchased 100 shares of ZYX at a share price of $41.75. He thinks the stock
might trade for this amount, or moderately higher or lower, over the near term so he writes an
out-of-the-money, three-month ZYX 45 call for $1.25. By selling the $45 call, the investor is
agreeing to sell ZYX at $45 should the stock increase above this amount and he is assigned.
Participation in a ZYX stock increase is therefore capped at $45 per share.
If the price of ZYX stock declines significantly below the purchase price of $41.75, the
investor will incur an unrealized loss on the 100 shares owned. However, this loss can be at
least partially offset by the premium of $1.25 per share taken in at the call's initial sale. The
break-even point for this strategy is a ZYX price of $41.75 (stock purchase price) - $1.25
(option sale price), or $40.50. In other words, this $1.25 represents the amount of downside
price protection on the ZYX shares.
Before option expiration early assignment is always possible. If assignment is received on or

before the ex-dividend date then the investor is obligated to sell his 100 ZYX shares and will
not be eligible to receive the regular dividend paid to shareholders.
 ZYX closes below the strike price at expiration

 ZYX closes above the strike price at expiration
 Assignment before expiration
Close Below Strike Price
ZYX closes below 45 at expiration - no assignment on
short call
In this case, the call option will expire worthless and the investor keeps the premium of
$1.25, or $125 total, for the call contract. Since there is no assignment, the 100 ZYX shares
will be retained as well. However, the net effective cost of the shares is reduced by the
premium taken in. The result is a net share cost of: $41.75 stock purchase price - $1.25 call
premium received = $40.50 net. Any dividends paid during the lifetime of the call contract
would be kept as well.
If at expiration ZYX closed above the stock purchase price of $41.75 both the covered call
writer and the stock investor not writing a call would see a profit on the 100 shares. However,
only the call writer's return would be increased by the $125 option premium received. If at
expiration ZYX closed below the stock purchase price both investors would see a loss on the
100 shares, but only the call writer would have the loss at least partially offset by the
premium taken in.
After expiration, the covered call writer is now free to write another call covered by the 100
ZYX shares, and can choose a strike price and expiration month that fit his current market
opinion and time frame for it. By doing so, taking in additional premium results in an even
lower net purchase cost for the 100 shares, generates additional premium income, and
provides limited downside stock price protection for the lifetime of the newly written call
contract.
Close Above Strike Price

ZYX closes above 45 at expiration - assignment on short
call
In this case, the short call will expire in-the-money and the call writer can expect assignment.
No matter how high ZYX has risen, the investor is obligated to sell his shares at the strike
price of $45 per share so the upside profit potential on the shares is capped. However, the
investor keeps the option premium received and will realize the position's maximum profit
calculated in advance. This amount would be: ($45 strike price - $41.75 stock purchase price)
+ $1.25 call premium received = $4.50, or $450 total. Any dividends received before
expiration would increase this profit amount.
Consider the overall return on this covered call position for the three-month life of contract if
the stock is called away at expiration:
The covered call writer's profit of $450 would represent a return on his initial $4,050
investment of approximately 11.1% over the three-month life of the call contract. A stock
investor purchasing 100 ZYX shares at the same $41.75 per share, not writing a call, and
selling the shares at $45 would see a profit of $325. This would represent a return on his
investment of only approximately 7.8%.
Before expiration the price of ZYX stock might rise well above the $45 strike price, and
assignment at expiration seems likely but undesirable. In this case the investor may make a
closing purchase of the ZYX 45 call at any time before it expires. The result would be an
unrealized profit on the ZYX shares offset partially by a losing transaction on the option
repurchase, but the investor retains his shares with the possibility of continued profits on the
upside.
Early Assignment
Assignment before expiration
Before a Dividend
Because the holder of any equity option has the right to exercise the contract before the
option expires, so may the writer of an equity call contract be assigned at any time before
expiration. However, early assignment on a short call can most likely be expected before the
underlying stock pays a dividend, the call is in-the-money, and the time premium amount of
the call's market value is less than the dividend amount.
If early assignment before a dividend occurs, the ZYX 45 call writer is obligated to sell the
100 underlying shares at the $45 strike price, just as when the call expires in-the-money at
expiration and assignment is received. The position's maximum profit may be realized at the
expected return, but less the dividend paid to underlying shareholders. And as with
assignment on a covered call at expiration, the investor will then have no position - no short
call and no 100 shares.
The timing for early exercise of an equity call to receive a dividend paid to underlying
shareholders is critical. A call holder must exercise a call contract no later than the day before
the ex-dividend date in order to purchase underlying shares and be eligible for dividend
payment. Therefore, you might expect notification of a possible early assignment on the ex-
dividend date itself. For this reason, any covered equity call writer should be aware of an
expected dividend amount and the timing of its payment.
Covered Calls Summary
The covered call write is a strategy that has the ability to meet the needs of a wide range of
investors. It can be used in a Keogh, margin, cash account or IRA against stock an investor
already owns or is planning to purchase. Today's investor has a choice of multiple strike
prices as well as short-term and long-term expirations (LEAPS®) from which to craft a
strategy that meets requirements for both returns on investment and limited downside stock
price protection. This strategy is widely considered a conservative one. It allows in investor
to be paid for assuming the obligation of selling underlying shares at a specified price higher
than purchase price, in return for a reduced downside risk from holding underlying shares (a
lower break-even point).
An investor who considers writing a covered call can calculate in advance an expected return
for the position if assignment is made and the stock is called away. Though early assignment
is always possible, it is somewhat predictable in certain cases before a dividend paid to
underlying shareholders.
Before writing any covered equity call, an investor should be comfortable with the possibility
that assignment is always possible whether because of an impending dividend or the stock
price rising above the strike price by expiration. If for whatever reason this is a totally
undesirable scenario, then the investor might choose not to write the call in the first place. If
downside stock price protection was the primary motivation for selecting this strategy, there
are other strategies, such as a protective put, which might achieve this more effectively.
Cash Secured Puts

Have you ever entered a limit order to buy a security at a price below its current trading
level? If so, you've most likely experienced a waiting game, and possibly a lengthy one
because the stock will not be purchased until it trades at or below your limit price. Instead of
simply waiting for that to happen you could take an approach that is a little more pro-active
and sell (write) a cash-secured put. You will be paid, in the form of the premium received for
selling the put, in return for accepting the obligation to buy underlying shares if assigned, and
at a price lower price that you select in advance. Many large portfolio managers as well as
individual investors find this an attractive means to acquire stock for their portfolios.
Definition
An investor who employs a cash-secured put writes a put contract, and at the same time
deposits in his brokerage account the full cash amount for a possible purchase of underlying
shares. The purpose of depositing this cash is to ensure that it's available should the investor
be assigned on the short put position and be obligated to purchase shares at the put's strike
price. While the cash is on deposit it may generally be invested in short-term, interest-bearing
instruments.
The net price paid for underlying shares on assignment is equal to the put's strike price minus
the premium received for selling the put in the first place. For this reason, the strike price
chosen, less the premium amount, should reflect the investor's target price for acquiring
underlying shares. Regardless of the direction the stock price takes after the put is sold, or
whether assignment is received or not, the put seller keeps the premium.
On the downside, the break-even point for this strategy is an underlying stock price equal to
the put's strike price less the premium received for selling it. If the stock declines
significantly below the strike price by expiration, on assignment the investor may be
obligated to purchase shares well above their current price level. Stock bought under this
circumstance may therefore reflect a loss compared to its market price at the time. However,
this loss would be unrealized as long as the investor holds the shares and is positioned to
profit from an increase in their price. Any investor whose motivation in writing a cash-
secured put is to buy underlying stock should therefore be committed in advance to a target
price for a possible purchase, and select a strike price accordingly.
On the upside the risk is one of opportunity loss. After selling the put the underlying stock
price can go up and remain above the put's strike price. In this case, neither a put seller, who
is not assigned, nor an investor who originally entered a low limit order for the stock, will
buy the stock. The put seller, however, keeps the put sale premium received.
Cash Secured Puts Example

How to Use the Cash-Secured Put to Buy Stock at a Lower
Price
transactions.
Example
After thorough research an investor decides he'd like to invest in ZYX stock. It's currently
priced at around $48 per share, but he feels it would be a good buy at around $45 (or lower)
and that the stock could reach that level within the next two months. The investor can always
place a limit order with his broker to buy ZYX shares at $45, but he decides to write a ZYX
put in order to acquire the same shares if he's assigned. In the marketplace there are two 2-
month ZYX puts available that might suit his purpose: an out-of-the-money ZYX 45 put
trading for a quoted price of $1.50, and an in-the-money ZYX 50 put trading for $4.00.
Selling either of these puts would result in a purchase of ZYX stock below the current market
price of $48 per share if assignment is made, but at different net prices. The investor should
sell one put contract for every 100 shares of stock he's willing to purchase.
Remember, by selling the put with a $45 strike the investor takes on the obligation to buy 100
ZYX at $45 per share should he be assigned at any time before the option contract expires,
and at a net purchase price of the $45 strike less the put premium received. By selling the $50
put the investor would be obligated, if assigned, to buy 100 ZYX shares at a net price of the
$50 strike less the put premium. In either case, the obligation is there to buy stock at these
prices no matter how low ZYX might decline in price by expiration.
With ZYX stock currently trading for $48 per share, consider the consequences of the
investor's choice between placing a limit order to buy 100 ZYX shares outright at $45 per
share with selling one of two put contracts:
 Out-of-the-money ZYX 45 put at $1.50

 In-the-money ZYX 50 put at $4.00
Selling an Out-of-the-Money Put

Placing a Limit Order to Buy 100 ZYX at $45
vs.
Selling 1 ZYX 45 Put at $1.50
In this case the investor is committed in advance to a purchase of 100 ZYX shares at $45,
below the current level of $48, so he sells the out-of-the-money ZYX 45 put for $1.50 and
deposits the purchase price of $4,500 ($45 strike x 100 shares) into his brokerage account in
case he's assigned. Consider three possible option expiration scenarios, and compare the
outcome of each to the placement of a limit order to buy:
 The stock remains above the $45 strike after the put sale, in which case the investor would
not be assigned and not buy 100 ZYX shares
 The stock is below $45 by expiration, in which case the investor can expect to be assigned
and obligated to buy the stock at $45
 The stock closes exactly at $45 at expiration
ZYX remains above $45 between put sale and expiration - investor not assigned
Whether by selling a cash-secured $45 put, or by entering a limit order to purchase the stock
at $45 per share, the investor will not buy shares and participate in a rise in the price of the
ZYX. However, if the investor had sold the $45 put, after expiration he would keep the $150
net premium received. At that point he could either sell another put, or possibly buy the 100
shares outright, at a current price less the $150, if he feels it's a good investment.
ZYX is below $45 at expiration – investor is assigned
Using a limit order to buy ZYX at $45 the investor would see an unrealized loss equal to the
amount ZYX stock was below $45 at expiration. By selling the $45 put for $1.50 the
investor's net purchase price for the 100 shares is actually lower than his target price of $45:
$45 strike - $1.50 premium received = net share price of $43.50. Only below this price, the
break-even point for the strategy, would the investor begin to see an unrealized loss on his
stock purchase. Should ZYX decline significantly by expiration the investor still has the
obligation to buy the stock at $45, whether by limit order or put sale.
ZYX is exactly at $45 at expiration
The investor may be in either situation described above. With a limit order to buy at $45 he
may or may not have bought the stock, depending on whether it traded at or below $45 before
expiration. If the put was sold instead, the investor may or may not be assigned on this
expiring at-the-money put contract, and may not be notified by his brokerage firm until the
next business day after expiration. Assigned or not, he retains the put premium received.
Selling an In-the-Money Put

Placing a Limit Order to Buy 100 ZYX at $46
vs.
Selling 1 ZYX 50 Put at $4.00
Selling an out-of-the-money put is one way to purchase underlying shares below current
trading levels, but an investor might also consider selling an in-the-money put. Depending on
the amount of premium received, this approach may also provide a purchase price that fits an
investor's target price. One benefit of this approach is that the investor's chance of being
assigned and purchasing stock is greater than from selling an out-of-the-money put. This is
because the put is already in-the-money, so the underlying stock price does not need to drop
for possible assignment at expiration. Another benefit is that the investor keeps a larger
premium amount for selling an in-the-money put in case the stock price increases above the
strike price and the option expires out-of-the-money and worthless.
Once again we will assume ZYX is currently trading at $48, and that an investor would like
to own ZYX, but not at this level. He thinks that ZYX would be a good buy at a lower price,
and is committed to a purchase around $46, so he sells an in-the-money ZYX 50 put for
$4.00. If assigned at any time before expiration, the investor's net purchase price fits his
target price: $50 strike price – $4.00 premium received = $46 per share. After the put's sale,
the investor deposits into his brokerage account the full stock purchase price of $5,000 ($50
strike x 100 shares) in the event he is assigned.
Comparing each to the placement of a limit order to buy, consider four possible option
expiration scenarios:
 the stock remains above the $50 strike after the put sale, in which case the investor would
not be assigned and not buy 100 ZYX shares
 the stock is below $50 by expiration, but above the limit price of $46, in which case the
investor can expect to be assigned and be obligated to buy the stock at $50
 the stock is below $46 by expiration in which case the investor can expect to be assigned
and be obligated to buy the stock at $50
 the stock closes exactly at $50 at expiration
ZYX remains above $50 between put sale and expiration - investor not assigned
Whether by selling a cash-secured $50 put or by entering a limit order to purchase the stock
at $46 per share, the investor will not buy shares and participate in a rise in the price of the
ZYX stock. However, if the investor had sold the $50 put, after expiration he would retain the
$400 net premium received. At that point he could either sell another put, or possibly buy the
100 shares outright, at a current price less the $400, if he feels it a good investment.
ZYX drops below 50, but remains above 46 by expiration - investor assigned.
Selling the $50 cash-secured put for $4.00 allowed the investor to buy ZYX at his net target
cost of $46, even though ZYX never traded there. He has no unrealized loss on the stock
purchase since $46 ($50 strike - $4.00 premium received) is his break-even point. Had he
used a limit order to buy ZYX at $46, he would not have purchased any stock.
ZYX drops below 46 by expiration - investor assigned
Whether by selling a cash-secured $50 put and being assigned, or by entering a limit order to
purchase the stock at $46 per share, the investor will buy 100 ZYX shares. In either case,
however, the investor would have an unrealized loss on the stock purchase by the amount
ZYX is below $46 at expiration.
ZYX remains above $46 after put purchase but is exactly at $50 at expiration
With a limit order to buy at $46 the investor will not buy 100 ZYX shares; by selling the $50
put he may or may not be assigned and buy the stock. If no assignment is received
beforehand, the investor may or may not be assigned on this at-the-money put contract at
expiration, and may not know which is the case until he's been notified by his brokerage firm
on the next business day. Assigned or not, he retains the put premium received.
Cash Secured Puts Summary

Selling a cash-secured put is a strategy that allows an investor to be paid a premium for the
obligation to buy a particular stock at the put's strike price if he's assigned. This strategy
provides him the opportunity to purchase an underlying security for a price that is lower than
it is currently trading. The premium received for selling the put can give him some downside
price protection by lowering his break-even point on the stock purchase, while placing no
limit on how high the stock can be subsequently sold. On the upside, the investor's risk is one
of opportunity loss if the stock increases, he's not assigned and shares are not purchased. But
assigned or not, he keeps the put premium received.
By selling an out-of-the-money put an investor can select a target price for possible stock
purchase if the stock price drops and assignment is received. On the other hand, by selling an
in-the-money put he might be able to purchase underlying shares at a target price below
current price levels, but without a drop in underlying stock price.
Note: Assignment prior to expiration

Many option professionals will exercise deep in-the-money puts before expiration when their
current market premiums have little or no time value remaining. For this reason, investors
with short positions in such puts might receive early assignment.
cboe.com
Covered Combinations
4-5 minutes
Who Should Consider Writing Covered Combinations?

 An investor who is moderately bullish on a particular stock.
 A stock-owning investor who is looking for a strategy that might help enhance his
return further than with a simple covered call.
 An investor who is not sure this is the best time to establish a position in a particular
stock, but might be interested in buying only half of the position now and the
remainder on a pullback at a reduced price.
The covered combination is a strategy that allows an investor to receive premium income in
exchange for agreeing to double his stock position in the event of a downward price move,
enhancing his rate of return on owned shares on the upside, or lowering the break-even point
on those owned shares in a static market. Anyone who has invested in stocks or written a
covered call might want to consider this strategy. The shares covering this combination can
be previously purchased or bought at the same time the combination is written.
Definition
A covered combination is simply two strategies in one: the simultaneous sale of both a
covered out-of-the-money call and an out-of-the-money cash-secured put, both with the same
expiration month. Two premiums are therefore received, one for the call and another for the
put. If the investor owns 100 shares of underlying stock then these shares cover the written
call on the upside. If the full cost of purchasing 100 additional shares is also deposited in the
investor's brokerage account, then this cash secures the written put on the downside if he is
assigned. Consider three possible ways to view this strategy's performance, depending on
movement of the underlying stock's price.
On the upside, above the short call's higher strike price, this strategy performs like a covered
call. If the underlying stock closes above the call's strike price at expiration the investor will
most likely be assigned on this contract, but the short put (with a lower strike price) will
expire out-of-the-money and with no value. He will be obligated to sell his 100 shares at the
call's strike price, as he was willing to do when selling this combination. However, since he
received two premiums, one for the written call and one for the written put, the net sale price
for those shares will be the call's strike price plus the combined premium amount. If only a
single covered call had been written on his 100 shares then he would have only the single
premium from its sale to increase the shares' net sale price on assignment, and thus the return
on his 100-share investment.
On the downside this strategy performs like a cash-secured put. If the underlying stock closes
at any price below the short put's lower strike price at expiration, the written call will expire
out-of-the-money and with no value, but the investor can expect assignment on the written
put. In this case he'll be obligated to purchase an additional 100 shares, as he was willing to
do when this position was established, with the cash deposited in his brokerage account.
However, the net purchase price for these 100 shares will be the put's strike price less the
combined call and put premium amounts received when these options were sold.
If the underlying stock closes between the higher strike price of the call and the lower strike
price of the put at expiration, both options expire out-of-the-money and with no value. In this
case the investor keeps the combined call and put premium amounts received from the
original sale of these contracts. This premium could be viewed as income generated from the
original 100 shares of underlying stock purchased to cover the written combination,
enhancing the return on this investment. In addition, the combined call and put premiums the
investor keeps in effect lowers his cost basis for these 100 shares, and results in a lower
break-even point for holding them.
cboe.com
Covered Combinations Example

3-4 minutes
How to Use the Covered Combination to Increase Returns

or Double a Stock Position
transactions.
Example
An investor would like to buy 200 shares of ZYX, which is currently trading for $52 per
share. He thinks that it's a good buy at this price level, but feels that the stock might pull back
in the next few months. He's concerned with market volatility, but not enough to stop him
from making a partial purchase at this point. Instead of buying all 200 ZYX shares, he
purchases only 100 shares at $52. On the upside, if ZYX increases in price the investor is
willing to sell his 100 shares around $55 or above. On a pull back, he's willing to purchase an
additional 100 ZYX shares at a price somewhere below $50. Given these motivations, the
investor decides to write a combination, and selects an available out-of-the-money ZYX 55
call and an out-of-the-money ZYX 50 put, both expiring in 90 days.
He sells the ZYX call for a quoted price of $2.75 and the ZYX put for $2.50, receiving a
premium amount of: $2.75 call premium + $2.50 put premium = $5.25, or $525.00 total. The
100 ZYX shares he owns cover the written call. He also deposits into his brokerage account
the full cash purchase amount of $5,000 ($50 put strike x 100 shares) for the additional 100
shares he'll purchase if assigned on the written put, so this contract is cash-secured.
The investor is positioned in the market just as he wants. If ZYX declines, he's being paid for
the obligation to purchase an additional 100 shares at a lower price if assigned on the short
ZYX 50 put. As a result, he would own his desired 200 shares, but at an average cost less
than the current $52 per share level. On the other hand, if the stock rises he'll sell his original
100 ZYX at $55 per share if assigned on the short $55 call. If ZYX closes at expiration
between the call strike of $55 and the put strike of $50, both options will expire out-of-the-
money and with no value. The total premium amount of $525 will be retained with no further
option-related obligations.
The investor's covered combination transaction looks like this:
 ZYX closes above the call strike of $55

 ZYX closes below the put strike of $50
 ZYX closes between $50 and $55
 cboe.com
 Close Above Call Strike

 2 minutes

 ZYX is above $55 at expiration
 The ZYX 50 put option will expire out-of-the-money and worthless. The investor will
be assigned on the ZYX 55 call and is obligated to sell his 100 ZYX shares at the
call's strike price of $55. The result after expiration: no position in either ZYX stock
or options. However, he has received and keeps two option premiums for having sold
both a put and a call.
 The investor originally purchased 100 ZYX for $52 per share, for a total investment
of $5,200. After assignment, the total received from selling these 100 shares at a net
price of $60.25 per share is $6,025. The net stock profit is therefore: $6,025 received -
$5,200 paid = $825. This profit represents a return on the original $5,200 investment
in 100 ZYX shares of approximately 15.8% over three months.
 However, when establishing this position the investor also deposited cash, securing
the short put, for a possible purchase of an additional 100 shares if assigned on the
downside. Since the put's strike price is $50, a total of $5,000 ($50 strike price x 100
shares) was deposited. This brings the total assets committed up front to: $5,200 for
100 ZYX shares + $5,000 cash deposited = $10,200. Given this, the $825 profit from
assignment on the call represents a return on total assets committed of approximately
8.1% for three months.
 Keep in mind that no matter how high ZYX rises above $55 by expiration, the
investor has the obligation to sell ZYX at the call strike of $55 if assigned. However,
he has taken in both the put and the call premium to offset some of the upside
potential that might be missed.
 cboe.com
 Close Below Put Strike

 2 minutes

 ZYX is below $50 at expiration
 The ZYX 55 call option will expire out-of-the-money and worthless. The investor will
be assigned on the ZYX 50 put and is obligated to buy an additional 100 ZYX shares
at the put's strike price of $50. The result after expiration: a doubled stock position of
long 200 ZYX shares and no option position (they have expired). However, he has
received and keeps two option premiums for having sold both a put and a call.
 The net cost per share for the additional 100 ZYX purchased from the short put
assignment is: $50 put strike - $5.25 combined put/call premium received = $44.75.
This meets the investor's original goal of purchasing 100 additional ZYX shares on a
pullback at a price less than the written put's $50 strike. The investor is now long the
original 100 ZYX shares at $52 and the additional 100 shares at $44.75. The average
price for the 200 ZYX shares is therefore approximately $48.38.
 If this investor had originally bought 200 ZYX shares at $52, it would have cost him
$10,400. Since this investor bought only half of the position at $52 ($5,200 for 100
shares), and the rest on a pullback taking in two option premiums for a cost of $44.75
($4,475 for 100 shares), he has now spent a total of $9,675 for his desired 200-share
position.
 Keep in mind that no matter how low the stock has fallen below the put's $50 strike
price, the investor has the obligation to purchase an additional 100 ZYX at $50 per
share if assigned. The cash for this purchase, however, was deposited in his brokerage
account when the covered combination was sold.
 cboe.com
 Close Between Strikes

 2 minutes

 ZYX is between the strikes ($50 and $55) at

expiration
 In this case both options will expire out-of-the-money and worthless. The result after
expiration: the investor will not be assigned and so retains his original 100 ZYX
shares purchased at $52. In addition he keeps the combined call and put premiums of
$525, plus any dividend paid to ZYX shareholders. This $525 represents a return on
the original $5,200 ZYX investment of approximately 10.1% for three months. But
remember that the investor also deposited $5,000 cash into his brokerage account at
the onset of this position to secure his written $50 put. Therefore, the $525 premium
received and kept represents a return on the total $10,200 assets committed of
approximately 5.1% for three months.
 Since the investor retains the 100 ZYX shares originally purchased when the
combination was sold, the $5.25 combined premium for the call and the put has the
effect of lowering the cost basis for these shares: $52 purchase price - $5.25 premium
received = $46.75 reduced cost basis. This is also the investor's new break-even point
for these 100 shares in the future. He may now choose to sell another combination
against the existing stock position, or hedge the position in some other way. He is also
free to hold the stock and to profit as long as the shares remain above the new break-
even point of $46.75.
cboe.com
Covered Combinations Summary

2-3 minutes
The covered combination is a purchase of underlying shares along with the sale of an out-of-
the-money call and an out-of-the-money put. For this reason it can be viewed as two separate
strategies in one: a covered call, and a cash-secured put. An investor using this strategy has a
target of ultimately owning a certain number of underlying shares. He purchases half of the
shares when the combination is sold, and receives combined premiums for selling an
equivalent number of both call and put contracts covered by those shares. At the same time
he deposits cash for the purchase of stock from possible assignment on the short put. The
investor is then positioned and should be committed to:
 Selling his originally purchased shares in an up-market if assigned on the short call(s),
and at a better rate of return than a simple covered call writer
 Doubling his stock position on a pullback if assigned on the short put(s)
 Increasing his return and lowering his break-even point on the originally purchased
shares, which he retains in a static market if no assignment is received
Note: Assignment prior to expiration

It is always possible that the underlying stock's price will fluctuate above the call's strike
price and below the put's strike price during this position's lifetime. If this should happen it's
always possible that the investor will be assigned before expiration. Early assignment might
be expected on a short in-the-money call before the underlying stock pays a dividend, when
the time premium portion of the call's current market premium is less than the dividend
amount. For puts, many option professionals will exercise deep in-the-money puts before
expiration when their premiums have little or no time value.
Covered Combinations Worksheet

Download the "Who Should Consider Using Covered Combinations?" Worksheet
cboe.com
Equity Option Strategies - Equity Collar

2 minutes
Who Should Use Equity Collars?

 an investor who is looking to limit the downside risk of a stock position at little or no
cost
 an investor who is willing to forego upside potential in return for obtaining this
downside protection
Equity collars are used by investors whose primary concern is the downside risk of a stock
position. They are willing to place a cap on upside potential in order to limit their downside
risk at little, and sometimes no cost. Collars may be of special interest to those investors who
have one equity position that accounts for a large proportion of their net worth, and who may
not be able to reduce the size of this position. For these investors, low cost protection may
take precedence over maintaining upside potential.
Definition
An equity collar consists of the simultaneous purchase of a put option, and the writing of a
call option. Both options are out-of-the-money, and usually have the same expiration date.
Most often a collar is established against an existing equity position, with one put purchased
and one call written for every 100 shares held. It is also possible to establish a collar at the
same time that an equity position is purchased.
cboe.com
Equity Collars Example

3 minutes
How to Use an Equity Collar

Collars are used mostly by investors who have accumulated a large position in a given stock
(through an employee stock purchase plan, for example) and who are primarily concerned
about the downside risk of their holdings. These investors may be reluctant to sell their stock
for a variety of reasons: the tax liability could be substantial, or selling an employer's stock
may be sending the wrong kind of signal to management or other shareholders. These
investors are also willing to give up some of the stock's upside potential in order to obtain the
desired downside protection at little or no cost.
transactions.
Example
As an example, consider an investor who has accumulated 1,000 shares of XYX stock, now
trading at $44.75. This investor may be familiar with the purchase of protective puts but may
also be reluctant to spend the amount necessary to buy put options. This could be especially
true if the desired protection is for a relatively long period of time. If a 10-month 40 put
option on XYX could be purchased for $4.75, for example, the investor might be unwilling to
pay such a high premium.
In order to lower the net cost of the protection, the investor could purchase 10 of the 10-
month 40 puts, and, at the same time, sell 10 of the 10-month 55 calls for $4.50. The cost of
the put options can be partially if not fully offset by the premium received from writing the
call options. If the collar could be established for no net premium, then it would be what is
commonly known as a zero-cost collar.
The investor's 10-month $40-$55 equity collar transaction would look like this:
 XYX closes above the call strike of $55

 XYX closes below the put strike of $40
 XYX closes between $40 and $55
cboe.com
Close Below Put Strike

1 minute
XYX is below $40 at expiration

If XYX is trading below $40 at expiration, the investor will have the right to exercise the
put options and sell the shares at the strike price of $40. This represents the worst-case
scenario, and the investor will have to absorb a loss of $4.75 per share (the difference
between the stock price of $44.75 when the position initiated and the selling price of $40)
and a loss of $0.25 per share, which represents the cost of the collar. The total downside
risk, therefore, is $5.00 per share.
Note: If, prior to expiration, the investor decides to keep the shares, the put could be sold.
The proceeds from the sale of the put would partially offset the accrued loss on the stock.
cboe.com
Close Above Call Strike

1-2 minutes
XYX is above $55 at expiration

If XYX is trading above $55 at expiration, it is likely that the investor will be assigned on the
written $55 calls. Consequently, he will be forced to sell the XYX shares at the strike price of
$55. Remember that when call options are written against a long stock position, an obligation
to deliver those shares at the options' strike price is being assumed. If a buyer of the same
calls decides to exercise, then the writer must deliver the shares if assignment is received.
In establishing a collar, the obligation to deliver shares was assumed so that the call premium
could be used to partially offset the cost of the put option. The stock being called away at
$55, in this example, represents the investor's best-case scenario. A $10.25 gain (the exercise
price of $55 minus the original price of the stock, $44.75) will be realized less the $0.25 cost
of the collar. The upside, therefore, is limited to $10 per share.
XYX is trading between $40 and $55 at expiration

If the price of XYX is anywhere between $40 and $55 at expiration, both the put and call
options will be out-of-the-money and will expire worthless. The investor will keep the XYX
shares, and the only cost will have been that of establishing the collar, $0.25 per share in this
example. During this period, the investor will have retained ownership of the shares, with the
ability to vote and to receive dividends, if either applied.
Previous
cboe.com
Equity Collars Summary

2 minutes
An equity collar is simply the coupling of two basic, very commonly used equity option
strategies into one with a profit & loss profile that could suit most stock investors at some
point in their investing careers. For a position in the underlying stock, it combines the
downside price protection of a protective put in return for limited upside profit potential of a
covered call. Purchase of the out-of-the-money put can at least in part be financed by the
premium received from writing the out-of-the-money call, resulting in a relatively small net
debit for establishing the position. Depending on the strike prices chosen and their market
prices, an equity collar may from time to time be established at a net credit, with an investor
actually taking in money to protect underlying shares already owned. This strategy is
particularly appropriate for any investor who's net worth lies mainly in one large stock
position.
cboe.com
Iron Condor - Equity

3 minutes
Who Should Consider a Long Call Condor Spread?

 An investor who is anticipating minimal movement on a stock within a certain period
of time.
A Long Condor Spread with calls is the combination of two other popular option strategies. It
is a long call spread and short call spread. The Condor is a neutral strategy which allows an
investor the opportunity to profit from a somewhat narrow range in the underlying stock
during a specific period of time.
Definition
Buying equity calls as part of this strategy gives the buyer the right, but not the obligation, to
buy shares of underlying stock at a specified price (the strike price) at any time before a
specific time (the expiration date). Selling equity calls gives the seller the obligation to sell
shares of underlying stock at a specified price (the strike price) at any time before a specific
time (the expiration date) if assigned an exercise notice before the expiration date. Now that
you are aware of the rights and obligations of call sellers and buyers, you should also know
that this neutral strategy is covered with the purchase and sale of the same amount of calls.
The profit potential for a Long Condor Spread is limited to the difference in the strike prices
of the long call spread less the net debit paid for the spread. The maximum profit is achieved
when the stock is in between the strike prices of the two short calls. The financial risk is
limited to the net debit paid to establish the spread. The break-even points are the lower strike
plus the net debit paid and the highest strike less the net debit paid.
After the Condor is established, an increase in implied volatility will have a greater short term
negative financial impact on the options you sold than the positive financial impact on the
options you bought. A decrease in implied volatility will have a more favorable financial
effect on the short calls than the negative financial impact on the calls you bought. Volatility
up, call premiums up. Volatility down, call premiums down. Also it is very important to keep
in mind, an increase in implied volatility may imply more movement either up or down in the
stock price, which you don’t want with a neutral strategy.
Time decay will be favorable to this spread, because the near the money calls you sold will
have more time premium than the options you bought.
cboe.com
Iron Condor - Equity Example

3-4 minutes
The Equity Strategy Workshop is a collection of discussion pieces followed by interactive

worksheets. The workshop is designed to assist individuals in learning how options work and
in understanding various options strategies. These discussions and materials are for
educational purposes only and are not intended to provide investment advice.
Investment decisions should not be made based upon worksheet outcomes.
Access to, or delivery of a copy of, the Options Disclosure Document must accompany this
worksheet.
Example
transactions.
XYZ is trading at $45 in September. An options trader wants to implement a limited risk,
non-directional trading strategy on XYZ which is viewed as being a low volatility type stock.
This trader enters a Condor spread by choosing the following options:
Buy one October 35 Call at $11.00

Sell one October 40 Call at $7.00
Sell one October 50 Call at $2.00
Buy one October 55 Call at $1.00
Net debit equals $3.00
Consider the three possible scenarios at expiration:
Stock at $35 or Lower

All options will expire worthless and there will be a maximum loss of $3.00 ($300) which
was the cost of the Condor spread.
Stock at $55 or Higher

The long October 55 call expires worthless but the long October 35 call is now worth $20.
The short October 40 call is now worth $15 and the short October 50 call is worth $5. The
long call profit and the short call losses off-set each other so we still have a loss of $3 ($300)
which was the original net debit we paid to initiate the trade.
Stock Between $40 and $50

The long October 35 call is now in-the-money. The short October 40 call is also in-the-
money. The October 50 and 55 calls expire worthless. We paid $3 to initiate the trade so our
maximum profit was achieved at $2 ($200).
For those who are neutral on a particular stock over the near-term, and who require a known,
limited risk and reward, the Long Condor Spread might be an appropriate strategy to use.
Purchasing a Long Condor Spread one time can usually require a small initial cash
investment to achieve a profit if your neutral forecast proves correct.
cboe.com
Butterfly - Equity
3-4 minutes
Who Should Consider a Long Call Butterfly Spread?

 An investor who is anticipating minimal movement on a index within a certain period
of time.
A Long Call Butterfly Spread is the combination of two other popular option strategies. It is a
Bull Call Spread and a Bear Call Spread. The Butterfly is often considered a neutral strategy
which allows an investor the opportunity to profit from a somewhat narrow range in the
underlying index during a specific period of time.
Definition
Buying index calls as part of this strategy gives the buyer the right, but not the obligation, to
buy upon exercise the value of the underlying index at the stated exercise (strike) price before
the option expires. American-style index options may be exercised at any time before the
contracts expire. European-style index options may be exercised only within a specific period
of time, generally on the last business day before expiration. However, any long index option
may be sold in the marketplace on or before its last trading day if it has market value. All
index options are cash settled. For contract specifications for various index option classes,
please visit the Index Options Product Specifications.
The seller of an index call option has the obligation to sell the value of the underlying index
at the stated exercise price if assigned an exercise notice before the option expires. If assigned
on an in-the-money contract, the index call seller will pay the cash settlement amount (the
difference between the call’s strike price and the exercise settlement value of the underlying
index) in cash to a buyer who has exercised a similar contract. Now that you are aware of the
rights and obligations of index call sellers and buyers, you should also know that this neutral
strategy is established with the purchase and sale of the same amount of calls.
The profit potential for a Long Call Butterfly Spread is limited to the difference in the strike
prices of the long call spread less the net debit paid for the spread. The maximum profit is
achieved at expiration when the value of the index equals the strike price of the short calls.
The financial risk is limited to the net debit paid to establish the spread. The break-even
points are the lower strike plus the net debit paid and the highest strike less the net debit paid.
After the Butterfly is established, an increase in implied volatility will have a greater negative
financial impact on the options you sold than the positive financial impact on the options you
bought. A decrease in implied volatility will have a more favorable financial effect on the
short calls than the negative financial impact on the calls you bought. Keep in mind, volatility
up, call premiums up. Volatility down, call premiums down. It is also very important to pay
close attention to an increase in implied volatility which may imply an increase in movement
either up or down in the index, which you don’t want with a neutral strategy.
Time decay will be favorable to this spread because the at-the-money calls you sold will have
more time premium than the options you bought.
cboe.com
Example
2-3 minutes
transactions.
XYZ is trading at $40 in September. An options trader wants to implement a limited risk,
non-directional trading strategy on XYZ which is viewed as being a low volatility type stock.
This trader enters a Butterfly spread by choosing the following options:
Buy one October 35 Call $5.65

Sell two October 40 Calls at $2.50 (5.00)
Buy one October 45 Call at $ .80
Net debit equals $1.45
Consider the two possible scenarios at expiration:
Stock at $40
The short October 40 calls and the long October 45 call all expire worthless but the long
October 35 call is all intrinsic value and now worth $5. But remember it cost us $1.45 to
initiate this trade so our maximum profit is $3.55 = $5 - $1.45
Stock below $30 or above $50

Maximum loss will occur if the stock is below $35 or above $45. With the stock closing at
$35 all options will expire worthless resulting in a maximum loss of $1.45. If the stock closes
above $45 any profit attained from the two long calls will be offset by the two short calls and
once again the maximum loss of $1.45 will occur, which was the price paid to initiate the
trade.
For those who are neutral on a particular stock over the near-term, and who require a known,
limited risk and reward, the Long Call Butterfly Spread might be an appropriate strategy to
use. Purchasing a Long Call Butterfly Spread one time can usually require a small initial cash
investment to achieve a profit if your neutral forecast proves correct.
cboe.com
Equity Option Strategies - Stock Repair

2-3 minutes
Who Should Consider Using the Stock Repair Strategy?

 An investor who owns shares purchased at a price well above the current market
price, and whose goal is to simply break-even on this position
 An investor who is willing to give up any profit potential above the new, reduced
break-even point
 An investor who is unwilling to commit additional funds to the current losing stock
position
The goal of the strategy is to reduce the investor's break-even price, without having to assume
any additional downside risk.
Please note: This transaction must be done in a margin account.
Definition
An investor has bought shares in a non-optionable stock and has seen its value decline after
purchase. He is now simply looking to break-even and has two choices: "hold and hope" or
"double up."
The "hold and hope" strategy requires that the stock retraces its fall all the way back to the
investor's purchase price, an event that may be a long time in the making. The "double up"
strategy, i.e., purchasing additional shares at a now lower price, does lower the investor's
break-even point, but it requires that additional funds be committed to the strategy. It also
increases the downside risk of the position by the additional shares purchased. However, an
investor who has an unrealized loss on an optionable stock has a third alternative: the repair
strategy.
The repair strategy is built around an existing stock position, usually a stock that is now
trading at a lower price than the investor's original cost. For every 100 shares held, 1 call
option is purchased and 2 call options with a higher strike price are sold, with all options
having the same expiration month. These purchases and sales are structured so that the
investor's cash outlay is minimal or none.
cboe.com
Stock Repairs Example

2-3 minutes
How to Use the Repair Strategy

transactions.
Example
An investor has purchased 100 shares of XYZ stock at $50 and seen the value of these shares
fall to the current price of $40. He is not willing to invest more capital to this losing stock
position, doesn't want any more downside risk than he already has, and is happy to just break
even. He decides to establish a repair strategy.
This investor could purchase 1 60-day XYZ 40 call at $3.00 and simultaneously sell 2 60-day
XYZ 45 calls at $1.50, a strategy that by itself could be referred to as a "ratio call spread"
Note that in this case the spread costs the investor no debit (or credit). The cost of the
purchased calls ($3.00 x 100 = $300) is fully offset by premium received from the sale of the
written calls ($1.50 x 2 x 100 = $300).
The purchase of the 1 XYZ $40 call, gives the investor the right to purchase an additional 100
shares at a cost of $40 per share. The 2 written $45 calls means that the investor could be
obligated to sell 200 shares of XYZ at $45 if assigned. Currently, the investor holds only 100
shares, but if needed the long $40 call could be exercised and another 100 shares purchased at
$40 to cover the assignment.
Consider four possible scenarios at expiration:
 XYZ falls and closes at $35

 XYZ is unchanged and closes at $40
 XYZ rises and closes at $45
 XYZ rises and closes at $50
cboe.com
Stock Declines
1-2 minutes
XYZ falls to $35 at option expiration
If at expiration the price of XYZ has continued to decline and closes at $35, both the long 40
call and the short 45 calls will expire out-of-the-money and worthless. Since the investor
initiated the option position at no cost and all of these options have expired with no value, the
option strategy has had no impact on the overall position. The investor has seen an additional
$5 per share loss (or $15 from the original stock purchase price) accrue on the original shares,
the same as would have resulted had the shares simply been held on to and the repair strategy
not been used.
It should be noted that if the repair strategy is utilized, as the stock continues to decline it will
not protect the investor against any further loss from the underlying stock position. If the
investor is expecting the price of XYZ to continue to fall, a strategy other than the repair
strategy might be considered.
cboe.com
Stock Unchanged
2 minutes
 Cboe
 Strategies
o Strategies Main
o Beginner Strategies
o Intermediate Strategies
o Advanced Strategies
o Product-specific Strategies
o LEAPS® Strategies
 Advanced Strategies
o Advanced Strategies
o Stock Repairs Strategy
o Iron Condor - Equity
o Butterfly - Equity
o Buying Index Straddles Strategy
o Iron Condor - Index
o Butterfly - Index
 Stock Repairs Strategy
o Stock Repairs Strategy
o Stock Repairs
o Stock Repairs Example
o Stock Declines
o Stock Unchanged
o Stock Higher
o Stock at Purchase Price
o Stock Repairs Summary
 Stock Repairs Strategy

o Stock Repairs
o Stock Repairs Example
o Stock Declines
o Stock Unchanged
o Stock Higher
o Stock at Purchase Price
o Stock Repairs Summary

 *Third Party Advertisement
XYZ is unchanged at $40 at option expiration
If at expiration the price of XYZ is unchanged over the price when the repair was established
and closes at $40, the situation is very similar to the one above. All of the call options expire
with no value, and the investor is left with the shares originally purchased at $50 and the
same $10 per share unrealized loss. Once again the repair strategy has neither helped the
original stock position nor increased its risk.
Previous Next
Related Links
 Strategies Main
 An Introduction to Spreads
*Third Party Advertisement
cboe.com
Stock Higher
2 minutes
XYZ rises to $45 at expiration
If XYZ has increased and closes at $45 at expiration, the investor's short 45 calls will expire
exactly at-the-money and with no value. However, the investor's long calls will be in-the-
money and worth $5. If the long call is sold the investor will have a net $5 option profit,
keeping in mind that the repair strategy was established for no cost. On the long stock
position, with XYZ at $45 the unrealized loss on the shares originally purchased at $50 will
be reduced to $5. Taking this $5 stock loss and the $5 profit on the option position, the
investor breaks even on the overall position.
Notice that what the investor has succeeded in doing is reducing the break-even point on his
stock position from the shares' initial cost of $50 to a lower XYZ stock price of $45. In other
words, the repair strategy does not need the underlying stock to at least partially recover over
the original stock purchase price in order to obtain the desired result - breaking even on the
overall stock repair position.
cboe.com
Stock at Purchase Price

2-3 minutes
XYZ rises to $50 at expiration
Should XYZ rally back to the shares' initial purchase price of $50 by option expiration, the
investor's position will be as follows:
 long 100 shares will break-even

 long 1 XYZ 40 call, now worth $10 (value at option's sale)
 short 2 XYZ 45 calls, each now worth -$5 (cost of options' repurchase)
The net value of the options equals zero: (-$5 purchase price x 2 contracts x 100) = ($10 sale
price x 1 contract x 100) = $0. Since the values of the options cancel out and the stock is at its
original cost, the overall position breaks even.
Above an XYZ price level of $50 at expiration, the investor will see a net loss on net option
value. However, this option loss will be offset by the profit seen on the original share
purchase. This is the "downside" of the repair strategy in this particular case: the best the
investor can do with the total position is to break even.
Changing Opinion?
If XYZ stock has risen to the original purchase price of $50 at expiration the investor might
again become bullish on the stock and no longer be satisfied with just breaking even at the
new reduced break-even point. In this case, the investor might liquidate the option position
for little or no cost. If he sells the XYZ 40 call for its intrinsic value of $10 ($50 stock price -
$40 strike price), and purchases the 2 XYZ 45 calls for their intrinsic value of $5 each ($50
stock price - $45 strike price), then he has closed the option position for no net cost beyond
commissions. He would then be left with his original 100 shares of XYZ and be positioned to
profit if they increase in price.
cboe.com
Stock Repairs Summary

3-4 minutes
The stock repair strategy is ideal for an investor holding a stock position on which he has an
unrealized loss and would be satisfied to simply break even. It helps the investor by reducing
his stock position's break-even point for little or no out-of-pocket cost. The strategy does not
protect the existing stock position from further downside loss, but doesn't increase risk on the
downside either. In return, the investor generally gives up any upside potential beyond the
new reduced break-even point.
Determining Strike Prices

One consideration when establishing the repair strategy is which option should be purchased,
and which should be sold. Note that in our example the unrealized loss on the stock was $10
dollars and the strike price interval between the options chosen was $5, half the unrealized
loss. If an investor was holding a stock now trading at $90 with an original cost of $110 (i.e.,
a $20 unrealized loss), he should look to purchase the $90 calls and sell the $100 calls - a $10
spread in strike prices. If an investor purchases at-the-money options, then he should consider
selling out-of-the-money options that are approximately at the halfway mark between the
current stock price and the original acquisition cost.
Can the Repair Strategy be implemented for all stocks that are trading below the purchase
price? Unfortunately not. The strategy will generally work for stocks that are down 20% from
their entry point (using options that may have 60 to 90 days to expiration), but will prove
inadequate for stocks down 40% or 50%. In the latter cases, investors will find that selling
two out-of-the-money calls will not generate enough premium to finance the one at-the-
money call purchased.
Finally, very often, the strategy can be initiated for a small credit or a small debit. An investor
might still consider the strategy in those cases were he may have to pay $0.25 or $0.50 for
initiating the option position. In these cases the investor may give up this small debit no
matter how high the stock increases in price. However, he might find that the overall benefits
of the strategy are worth a minimal outlay. On the other hand, if the option position is
established for a small credit, above the reduced break-even point he might keep this credit.
Final profit & loss scenarios from using the repair strategy will vary depending on the
original stock purchase price, the stock's price when establishing the repair, the strike prices
chosen and whether the option position is established at no cost or for a small debit or credit.

Equity Option Strategies - Buying Calls

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Equity Option Strategies - Buying Calls

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Equity Option Strategies - Buying Calls

Who Should Consider Buying Equity Calls?

Consider three possible scenarios at expiration:

 ZYX closes above the break-even point

Close Above Break-Even Point

$51.00 ZYX stock price

$6.00 intrinsic value received at call's sale

Close Between Strike and Break-Even

$3.25 premium initially paid for call

Close Below Strike

Buying Calls Summary

Buy Call Strategy Worksheet

Equity Option Strategies - Buying Puts

Who Should Consider Buying Equity Puts?

Buying Puts Example

Participate in Downward Stock Price Movement With

Consider three possible scenarios at expiration:

 ZYX closes below the break-even point

Close Below Break-Even Point

ZYX is below break-even point of $47.00 at expiration

$50.00 put strike price

$7.00 intrinsic value received at put's sale

Close Between Strike and Break-Even

ZYX is between $50 and $47.00 at expiration

$50.00 put strike price

$3.00 premium initially paid for put

Close Above Strike

ZYX is at or above $50 at expiration

Buying Puts Summary

Equity Option Strategies - Covered Calls

Covered Calls Example

Writing a Covered Call to Generate Income and Provide

Before option expiration early assignment is always possible. If assignment is received on or

Consider three possible scenarios at expiration:

 ZYX closes below the strike price at expiration

Close Above Strike Price

Cash Secured Puts

Cash Secured Puts Example

 Out-of-the-money ZYX 45 put at $1.50

Selling an Out-of-the-Money Put

ZYX is below $45 at expiration – investor is assigned

ZYX is exactly at $45 at expiration

Selling an In-the-Money Put

ZYX drops below 46 by expiration - investor assigned

Cash Secured Puts Summary

Note: Assignment prior to expiration

Who Should Consider Writing Covered Combinations?

Covered Combinations Example

How to Use the Covered Combination to Increase Returns

The investor's covered combination transaction looks like this:

Consider three possible scenarios at expiration:

 ZYX closes above the call strike of $55

 Close Above Call Strike

 ZYX is above $55 at expiration

 Close Below Put Strike

 ZYX is below $50 at expiration

 Close Between Strikes

 ZYX is between the strikes ($50 and $55) at

Covered Combinations Summary