Option Strategies

Options pricing consists of Intrinsic Value (IV) and Time Value (TV):

1️⃣ Intrinsic Value (IV) 🎯

• The real value of an option if exercised immediately.
• Formula:
  • Call IV = Spot Price – Strike Price
  • Put IV = Strike Price – Spot Price
• Effect on Strategies:
  • ITM options have high IV & lower time decay (Theta).
  • OTM options have zero IV and rely purely on time value.
  • Used in safer strategies like Covered Calls, ITM Option Buying.

2️⃣ Time Value (TV) ⏳

• The extra premium due to time left until expiry.
• Formula:
  • TV = Option Price – IV
• Effect on Strategies:
  • ATM options have the highest time value.
  • Longer expiry = Higher TV (but decays faster as expiry nears).
  • Used in Theta-based strategies like Iron Condors, Credit Spreads.

📌 Key Takeaway:

✅ ITM options have more IV (safer but expensive), while ATM & OTM options rely on time value (cheaper but riskier). Strategy choice depends on risk appetite & market conditions.

A payoff graph visually represents the potential profit or loss of an options strategy at different stock prices upon expiration. It helps traders understand risk, reward, breakeven points, and strategy effectiveness.

📌 Components of a Payoff Graph

1️⃣ X-Axis (Stock Price at Expiry) – Shows the price of the underlying asset.
2️⃣ Y-Axis (Profit/Loss) – Represents the trader's gain or loss.
3️⃣ Breakeven Point (BE) – Where the trader neither makes a profit nor incurs a loss.
4️⃣ Maximum Profit & Loss – Indicated by the flat or rising/falling sections.

Debit and credit spreads are multi-leg options strategies used to manage risk and cost. The key difference lies in how they generate or require capital.

Implied Volatility (IV) measures the market's expectation of future price fluctuations. It significantly affects option pricing and strategy selection.

📌 How IV Affects Option Prices?

🔹 Higher IV = Expensive Options (Increased Premiums)
🔹 Lower IV = Cheaper Options (Decreased Premiums)
🔹 Effect on Greeks:

• Vega ↑ with IV, meaning options become more sensitive to IV changes.
• Theta ↑ when IV is high, leading to faster time decay.

A trader chooses between a Long Call and a Long Put based on their market outlook: bullish or bearish. Here's a quick comparison to help decide:

📌 Naked Call Writing (Short Call) – HIGH RISK 🚨
✅ Bearish View (Expecting price to stay below strike).
❌ Unlimited Losses if stock price rises sharply.
❌ High Margin Requirements – Risk of margin calls.
❌ Short Squeeze Risk – Prices can spike unexpectedly.

📌 Naked Put Writing (Short Put) – Still Risky 🔻
✅ Bullish View (Expecting price to stay above strike).
❌ Large Losses if stock price crashes.
❌ Forced Assignment – May need to buy at strike price.
❌ Market Gaps & Crashes can cause heavy losses.

1️⃣ Long Straddle:

• When to Use: Expect high volatility, but unsure of the direction (e.g., earnings report).
• Features:
  • Same strike price for call and put.
  • Higher cost (both options are at-the-money).
  • Unlimited profit if stock moves significantly.
  • Max loss: Total premium paid.

2️⃣ Long Strangle:

• When to Use: Expect large price movement, but want lower cost.
• Features:
  • Different strike prices (out-of-the-money).
  • Lower premium (cheaper than a straddle).
  • Unlimited profit but needs a larger move.
  • Max loss: Total premium paid.

• Straddle: Use if you expect significant movement in any direction and want to hedge against uncertain price action. Ideal for high volatility events (earnings, announcements).
• Strangle: Use if you expect a large move but at a lower cost than a straddle, or when the stock is far from the current price and you want to pay less premium.

1️⃣ Buying Puts (Protective Put):

• When to Use: To protect against a downside risk while holding a stock.
• How It Works: Buy a put option below the current stock price.
  • If the stock drops, the put gains value, offsetting losses.
  • If the stock rises, you only lose the premium paid for the put.
• Benefit: Downside protection with unlimited upside.

2️⃣ Covered Calls:

• When to Use: When you expect the stock to stay flat or rise slightly.
• How It Works: Sell a call option on the stock you own.
  • You collect the premium but limit your upside if the stock rises above the strike price.
  • If the stock doesn’t rise, you keep both the stock and premium.
• Benefit: Income generation with limited downside.

3️⃣ Collar Strategy (Protective Collar):

• When to Use: To limit both downside risk and upside potential.
• How It Works:
  • Buy a put for downside protection.
  • Sell a call to finance the put, capping your upside.
• Benefit: Low-cost protection with a capped range.

• Synthetic Long Stock:

  • Constructed by: Buying a call + selling a put at the same strike and expiry.
  • Mimics stock ownership: Profits and losses track the stock's movement as if you owned the stock.

• Synthetic Short Stock:

  • Constructed by: Selling a call + buying a put at the same strike and expiry.
  • Mimics shorting the stock: Profits when the stock falls, losses when the stock rises.

Benefits of Synthetic Positions:

• Cost-Efficient: No need to buy or short the stock, just use options (less capital required).
• Flexibility: Allows traders to replicate stock movements in different ways and manage risk more efficiently.

1️⃣ Bullish Market (Expecting Price to Rise):

• Long Call: Buy a call option for potential upside.
• Covered Call: Sell a call on stock you own to generate income.
• Bull Call Spread: Buy a call at a lower strike, sell a call at a higher strike for cost-efficiency.

2️⃣ Bearish Market (Expecting Price to Fall):

• Long Put: Buy a put option to profit from a price drop.
• Covered Put: Short stock and sell a put to collect premium.
• Bear Put Spread: Buy a put at a higher strike, sell a put at a lower strike to limit risk.

3️⃣ Neutral Market (Little Movement Expected):

• Iron Condor: Sell out-of-the-money call and put, buy further strikes for protection.
• Strangle: Buy out-of-the-money call and put for potential volatility.
• Covered Call: Generate income from selling calls on owned stock.

4️⃣ High Volatility (Expecting Large Movement):

• Straddle: Buy both a call and a put at the same strike for big price swings in either direction.
• Strangle: Buy call and put at different strikes for cheaper volatility play.

5️⃣ Low Volatility (Limited Price Movement):

• Iron Butterfly: Sell call and put at the same strike and buy further out-of-the-money options.
• Covered Call: Generate income from selling calls when price is stable.