If you go online, you can find hundreds of thousands of blogs discussing options trading essentials, definitions, and strategies. Their goal is to help options beginners decide whether to include these assets in their portfolios. That’s all good!
However, we all know that theoretical knowledge is only a part (the smaller part) of developing actual trading skills. Without a practical approach, knowing the definitions of what options are and how to trade options is worthless.
So, we’ll check out some simple trading options examples because implementing those definitions in practice is the best educational approach.
Trading Options Examples
As you already know, calls and puts are two types of options. Of course, we’ll see calls and puts examples. However, these aren’t the only trading options examples we’ll discuss. Our goal is to show you various options trading strategies, so you can find out how trade options work.
We’ll focus more on options strategies. But first, we’ll check out some commonly used terms in options trading, explain them, and give examples so that you can understand the strategies better.
Option calls example
Calls are options contracts that give you the right to buy 100 shares of the underlying at a particular price within a specific timeframe. Remember that you have the right, but you’re not obligated to exercise the contract. An example of a call would be:
The company’s stock trades at $100 per share. After your research, you believe the stock will go up to $120 per share within the next month. Here you have the strike price, $120, and the expiration date, after a month from now.
The more the underlying goes up, the better for the options contract. The maximum loss would be the amount you paid for the premium if the underlying doesn’t reach the strike price by the expiration date.
Conversely, if the asset’s price goes above the strike price, your profit would be the difference between these two prices minus the premium you paid.
For instance, if the stock goes at $130 (strike price $120), and you paid a $3 premium, your profit would be $7 per share. Of course, this example is strictly technical, without applying commissions and fees per contract.
Option puts example
Puts are the opposite of calls. If you buy a put option, you’re actually buying the right to sell shares of the underlying asset at a predetermined price within a specific timeframe.
The elements in puts are the same as those we saw in calls. You have a strike price and expiration date. However, in this case, you can profit if the underlying goes below the strike price. Here’s an example:
The underlying asset is a stock currently trading at $100 per share. You’re bearish and believe the stock will go down to $90 by the end of one month. So, you buy a put for $2 per share.
The lower the asset goes during the life of the premium, the better is for the contract value.
Let’s say that the underlying price goes to $80 per share. The profit would be the difference between the strike price and the asset’s current price minus the premium you paid. So, you’ll profit $8 per share (fees are not included).
OTO, ITM, and ATM options explained
The options contract can be out-of-the-money, in-the-money, and at-the-money. It’s important to understand these terms if you want to build a strategy or simply to decide whether an options contract is worth buying.
What is an ATM in options?
The options contract is at-the-money when the strike price matches the underlying asset’s current market price. The important thing to remember for the money options is that they don’t have intrinsic value but have time value up to the expiration date.
ATM options are often used for combinations. Traders use them to build a spread or a straddle.
ITM meaning in trading options
In-the-money options are contracts that have intrinsic value, and they are a profit opportunity for the holder.
Unlike ATM options, ITM calls and ITM puts are different. If the trader holds an ITM call, they can buy shares of the underlying at a lower price than the asset’s current price. If the trader holds an ITM put, they can sell shares of the underlying at a higher price than its current price.
When are options in-the-money?
A call option is in-the-money when the underlying market price goes above the option’s strike price. ITM puts have a higher strike price than the asset’s current market price.
Out-of-the-money option example
Out-of-the-money options have only extrinsic value. However, they aren’t the same as the money options.
Out-of-the-money calls have a higher strike price than the current market price of the underlying. Conversely, OTM puts have a lower strike price than the asset’s current market price.
As you can see, we have an opposite situation here than the one we explained about in-the-money options.
To give you an example, an out-of-the-money call has a strike price of $110 while the asset currently is trading at $100 per share. An OTM put would be if the same underlying asset (trading at $100) has an options contract with a $90 strike price.
Options Strategies Examples
Covered call
When the trader uses a covered call strategy, it means that they sell a call option on an underlying asset they already own. The “cover” is the trader's long position in the asset.
Suppose you have shares in a business. You write a call option on those shares, believing the asset won’t go up. If the asset moves above the strike price and the buyer of the option wants to exercise the contract, you already own the shares you have to give to the buyer.
A covered call is a neutral options strategy. Investors use it when they hold a long position in a particular asset they believe will not move significantly within the options contract timeframe in the next period. They use covered calls to profit from writing the premiums.
Here’s an example - You own shares and feel the stock won’t move within the next period. The stock is currently trading at $100, so you write a covered call option with a $110 strike price for a $1 premium.
If the stock doesn’t hit the $110 strike price, you keep the money from the premium. If it goes above the strike price, you’ll have to sell the shares to the buyer at the strike price.
Married put example
Married puts are similar to covered calls regarding protection against large losses. In the covered call strategy, the investor writes a call on an asset in which they hold a long position. In the married put strategy, the investor buys an at-the-money put on the same asset.
Unlike the covered call, the married put strategies are bullish, meaning they’re often used by investors who want to protect themselves against a surprise down movement of the asset. Check out this example:
You purchase 100 shares of a particular stock, currently trading at $100. At the same time, you buy a $1 put option with a $90 strike price. In this case, you’re bullish, but you’re buying the put option just in case the price drops.
If the stock goes below $90, you’ll have a loss on your long position. However, the loss can be partially compensated by the profit from the put option.
As you can see, we gave you an example of a put options contract. The difference between a put and a married put is that the latter is a strategy where you purchase the put option and the underlying asset at the same time.
Options straddle
Here’s another neutral strategy - The options straddle is a strategy in which you buy an ATM call and an ATM put on the same underlying asset with the same strike price and expiration date.
Traders make this strategic move when they think there will be price changes within the period that follows but are uncertain about the direction.
This strategy is profitable and easy to set because the trader can earn money regardless of whether the asset goes up or down.
However, you should remember that options writers are also aware that a particular stock can move significantly after an anticipated event. The straddles you can buy will probably be more expensive than purchasing a call or a put.
Straddle profit, loss, and breakeven example
There’s an upcoming event, such as an earnings release or a passage of a law that you believe will shake the market about a particular company’s stock. Since you’re unsure about the stock’s direction, you decide to build options straddle.
The current price of the underlying asset is $100 per share. You buy an at-the-money call and at-the-money put for $10 each. Of course, both contracts have the same expiration date.
Now, let’s assume that the stock moved to $120. This is the breakeven point. You paid $20 for the call and put premiums; therefore, $120 per share can cover your cost of the contracts. If the underlying goes to $80 per share, you'll also reach the breakeven point.
In order to profit, the underlying has to move outside the $80-$120 range. For instance, if it goes to $150, your profit will be $150 current price - $100 strike - $20 premium = $30.
Unlike the profit, the potential loss is limited to the money you paid for the premiums. If the underlying stays at $100, the option will expire without value, and you’ll lose the premium, which is $20.
Option strangle
The rules are almost the same for options strangles and straddles. The difference is in the moneyness of the option contract.
For straddles, you buy at-the-money calls and puts, while for strangles, you buy out-of-the-money options. You can use this strategy when you believe that the underlying asset will make a huge move but you’re uncertain of the direction.
So, in a strangle strategy, the trader buys an OTM call and an OTM put on the same underlying asset with the same expiration date. Unlike the straddle strategy, the asset has to make a big enough move to cover the premium for both contracts and yield profit.
Strangle profit, loss, and breakeven example
ABC’s stock is currently trading at $100 per share. You believe that the stock will experience high volatility in the next period.
Therefore, you buy both a $10 call with a $130 strike and a $10 put with a $70 strike. This means that you paid $20 for both premiums.
Now, there are two breakeven points in strangles and straddles. If the asset goes to $150, you’ll neither lose nor profit. The put option is worthless, but the call option is profitable for $20, covering the premiums. The same applies if the asset goes to $50.
To profit, the stock has to go above $150 or below $50. If it goes to $160, your profit will be $160 current - $130 strike - $20 premium = $10
If the asset closes anywhere between your two strikes, you’ll lose $20, which is the money you paid for the premium. So, if we take the same example - your loss will be $20 if the stock hits anywhere between $70 and $130.
Vertical spreads
First things first! It’s important to note that the term spreads can have many different meanings in finances. Typically, it’s related to the difference between two yields, rates, or prices, but it can also have other meanings for investors.
In options, you can use a vertical, calendar, or diagonal spreads, meaning you buy and sell options of the same type on the same underlying simultaneously.
Vertical options spread can be bull calls, bear calls, bull puts, or bear puts spread. You should know that you can combine these main types to create a completely new type of options strategy, such as the iron condor, the butterfly spread, the iron butterfly, etc., which are more advanced options strategies.
Vertical spread types: bulls and bears
Bull call and bull put spreads are strategies utilized by bullish traders. These strategies include buying the options contracts with lower strikes and selling options with higher strikes.
Conversely, bear call and bear put spreads are strategies used by bearish traders. For these strategies, the trader buys options with higher strikes and sells options with lower strikes.
The bull call spread has a breakeven point equal to the call’s strike price plus the premium paid. The maximum loss equals the premium, while the maximum profit is the spread between the strike prices minus the premium.
The bear put spread has a breakeven point equal to the long put’s strike minus the premium paid. The maximum loss equals the premium paid, while the maximum profit is the spread between the strikes minus the premium.
Bear call and bull put spreads are used by options writers. The maximum profit from using these strategies is equal to the amount of the premium the writers sell. The maximum losses equal the spread between the strikes minus the premium received.
Which Option Strategy Is the Best?
The strategy you choose will depend on your position, whether you feel bearish or bullish, the upcoming events regarding a particular company or the market overall, and other factors.
Also, you should keep in mind that your trade level for options is very important, as not all strategies are available for each level.
Building an options strategy takes time and deep knowledge of the market. That’s why even experienced traders use alert services like Foolproof Options to get notifications on important market movements.
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