Options Trading Archives

Protective Put Options Strategy – Guide W/ Visuals

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 02:02 pm

The protective put options strategy (also known as a “married put”) consists of buying a put option against 100 shares of long stock.

As the name suggests, a protective put is a defensive strategy that reduces the risk of owning shares of stock.

When a put is purchased against 100 shares of stock, the risk of those shares is eliminated below the strike price of the put option. The risk reduction comes at the cost of increasing the breakeven price on the shares, as the shares must increase by the cost of the put option for the strategy to break even at the expiration date of the put option.

TAKEAWAYS

The protective put consists of 1.) purchasing 100 shares of stock and 2.) purchasing one put option.
Protective puts allow investors to sell their long stock at the puts strike price.
Protective puts are great for bullish yet jittery markets.
Max loss on the protective put is the current stock price minus the strike price
Max profit on a protective put is uncapped.

Protective Put Options Strategy Characteristics

Let’s go over the strategy’s general characteristics:

○Max Profit Potential: Unlimited

○Max Loss Potential: [(Stock Purchase Price – Put Strike Price) + Debit Paid for Put] x 100

○Expiration Breakeven: Stock Purchase Price + Debit Paid for Put

○Estimated Probability of Profit:

Less than 50% because the price paid for the put increases the effective purchase price of the shares.

To demonstrate these characteristics in action, let’s take a look at a basic example.

Protective Put: Profits/Losses at Expiration

In the following example, we’ll construct a protective put from the following option chain:

In this case, we’ll buy the 145 put for $5.00. Let’s also assume 100 shares of stock were purchased for $150 per share.

Initial Stock Purchase Price: $150

Long Put Strike Used: $145 Put

Debit Paid for Put: $5.00

Breakeven Price: $150 share purchase price + $5.00 put price = $155

Maximum Profit Potential: Unlimited

Maximum Loss Potential: $1,000 [(150 Stock Purchase Price – 145 Put Strike) + $5.00 Paid for Put] x $100

The following visual describes the position’s potential profits and losses at expiration:

Protective Put Trade Results

As we can see here, the position will be unprofitable at any stock price below $155. Since the shares were purchased at $150, this means the stock price must rise $5 before any profits occur at expiration. Because of this, the probability of making money on this trade is less than 50%, in theory. However, the risk of the shares has been eliminated below $145, which is the strike price of the protective put.

Below explains the performance of this position based on various scenarios at expiration:

Protective Put at Different Expirations

○Stock Price Below the Long Put Strike ($145)

The value of the 145 put offsets the losses on the long shares, capping the maximum loss potential to $1,000. For example, at $130, the 145 put will be worth $15 at expiration, resulting in a $1,000 profit on the long put. The long shares will have a loss of $2,000 since they were purchased at $150. Consequently, the net loss is $1,000.

○Stock Price Between the Long Put Strike ($145) and the Stock Purchase Price ($150)

The long 145 put expires worthless ($500 loss), and the long shares are unprofitable. The loss is therefore between -$500 and -$1,000.

○Stock Price Between the Share Purchase Price ($150) and the Breakeven Price ($155)

The long shares are profitable, but not more than the $5 premium that was paid for the 145 put. Overall, the position is not profitable.

○Stock Price Above the Breakeven Price ($155)

The profit on the long shares exceeds the $5 in premium that was paid for the 145 put. As a result, the position is profitable. The exact profits are equal to: (Stock Price – $155) x 100.

Great job! You’ve learned the general characteristics of the protective put strategy. Now, let’s go through some visual trade examples to understand the strategy’s performance through time.

Married Put (Protective Put) Trade Examples

In the following examples, note that we don’t specify the underlying because the same concepts apply to protective puts on any stock. Additionally, each example demonstrates the performance of a single married put position. When trading more contracts, the profits and losses in each case are magnified by the number of protective puts traded.

Let’s do it!

Profitable Protective Put - Trade Example #1

The first example we’ll look at is a scenario where a hypothetical trader makes a small profit after entering a protective put.

Share Purchase Price: $77.21

Put Strike and Expiration: Long 77.5 put expiring in 74 days

Premium Paid for Put: $4.95

Breakeven Price (Effective Share Cost):

$77.21 share purchase price + $4.95 put purchase price = $82.16

Maximum Profit Potential:

Unlimited

Maximum Loss Potential:

[($77.21 share purchase price – $77.5 put strike) + $4.95 premium paid for put] x 100 = $466

Let’s see what happens!

Protective Put #1 Trade Results

In the top half of the chart, we can see the stock price over time, as well as the long put strike and the position’s breakeven price. In the bottom half of the chart, we can see the performance of a married put’s components (the green line represents the combined performance of the components).

The above example demonstrates how purchasing a put against shares of stock reduces the overal profits on the long stock position. In this case, the married put position performs $495 worse than the long stock position, which is the cost of the 77.5 put.

Reducing Risk With a Protective Put - Trade Example #2

In the following example, we’ll investigate a situation where the stock price collapses after a hypothetical trader enters into a married put position. Here’s the setup:

Share Purchase Price: $254.53

Put Strike and Expiration: Long 245 put expiring in 37 days

Premium Paid for Put: $14.15

Breakeven Price (Effective Share Cost):

$254.53 share purchase price + $14.15 put purchase price = $268.68

Maximum Profit Potential:

Unlimited

Maximum Loss Potential:

[($254.53 share purchase price – $245 put strike) + $14.15 premium paid for put] x 100 = $2,368

Let’s take a look at the trade performance:

Protective Put #2 Trade Results

In this example, we can see that the stock price collapses from $254.53 to nearly $200 in a short period of time. Consequently, the long stock position suffers significant losses. However, the protective put position outperforms because the long put gains value as the stock price decreases. Additionally, we can see that the position’s losses are capped at $2,368, which is the maximum loss potential of this particular trade.

At expiration, the long put would expire to -100 shares of stock. Since the protective put trader already owns 100 shares of stock, the positions would offset and the trader would be left with no shares.

Final Word

Congratulations! You now know how selling the protective put options strategy works! Be sure to read the recap of main points below!

Combining stock with a long put is known both as a “protective put” and a “married put”.
Time decay works against the long put.
A rise in implied volatility increases the value of all options.
Because of the long stock, the upside in this strategy is capped, but this is lessened by the amount of premium paid for the put .

Next Lesson

Additional Resoures

Protective Put Married Put – The Options Industry Council

How the Covered Strangle Option Strategy Works (Guide W/ Visuals)

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 02:04 pm

The covered strangle strategy is a bullish strategy that consists of simultaneously buying 100 shares of stock while also selling a strangle. The strangle is “covered” because the long shares “cover” the risk of the short call. A normal short strangle position has unlimited upside risk, but when 100 shares are purchased, the upside risk of the strangle is eliminated.

A covered strangle position can be conceptualized in two ways:

1) Simultaneously selling a strangle and buying 100 shares of stock

2) Simultaneously buying a covered call (+100 shares, -1 call option) and selling a put

Since the covered strangle combines a covered call and a short put into one position, it is a strategy that can be used when an investor wants to sell their shares at a higher price, but would also be willing to buy more shares if the stock price falls.

TAKEAWAYS

A covered strangle is created by 1. owning 100 shares of stock 2. selling 1 out-of-the-money call 3. selling 1 out-of-the-money put.
Both options sold must be of the same expiration cycle.
Max profit potential for this trade is limited to the total credit received plus upper strike price minus stock price.
Max loss is great for the covered strangle, as a declining market will hit both the long stock and the short put.

Covered Strangle Trade Characteristics

Let’s go over the strategy’s general characteristics:

Max Profit Potential:

[(Call Strike Price – Stock Purchase Price) + Premium Received for Strangle] x 100

Max Loss Potential:

[(Short Put Strike Price – Strangle Credit) + Share Purchase Price] x 100

Breakeven Price at Expiration:

Stock Purchase Price – Premium Received for Strangle

To demonstrate these characteristics in action, let’s take a look at a basic example.

Covered Strangle Profit/Loss Potential at Expiration

In the following example, we’ll construct a covered strangle from the following option chain:

In this case, we’ll sell the 210 call and 190 put for a total credit of $8.09. Let’s also assume the stock price is trading for $200 when we put this trade on:

Initial Stock Purchase Price: $200

Strangle Strikes: $190 short put, $210 short call

Credit Received for Strangle: $8.09

Covered Strangle Breakeven: $200 share price – $8.09 strangle credit = $191.91

The following visual describes the position’s potential profits and losses at expiration:

Covered Strangle Trade Results

As we can see here, the covered strangle profits when the stock price is above the breakeven price. In other words, the strategy profits when the losses on the shares do not exceed the premium collected for selling the strangle.

Additionally, we can see that the profit potential is capped at any stock price above the short call strike. Lastly, you may notice the losses accelerate when the stock price is below the short put strike. At expiration, an in-the-money short put has a delta of +100. Since a covered strangle trader already owns 100 shares, their net position delta will be +200 if the stock price is below the short put strike price.

Great job! You’ve learned the general characteristics of the covered strangle strategy. Now, let’s go through some visual trade examples to see how the strategy performs through time.

Covered Strangle Trade Examples

In each example, note that we don’t specify the underlying, since the same concepts apply to covered strangles on any stock. Additionally, each example demonstrates the performance of a single covered strangle position. When trading more contracts, the profits and losses in each case are magnified by the number of covered strangles traded.

Let’s do it!

Small Covered Strangle Profits - Trade Example #1

The first example we’ll look at is a scenario where the stock price remains relatively flat after a hypothetical trader enters a covered strangle.

Initial Share Purchase Price: $212.44

Strangle Strikes and Expiration: Short 219 Call; Short 201 Put; Both options expiring in 63 days

Premium Collected for Strangle: $1.75 for the call + $0.83 for the put = $2.58

Breakeven Price: $212.44 share purchase price – $2.58 strangle credit = $209.86

Maximum Profit Potential: ($219 short call strike – $209.86 breakeven) x 100 = $914

Maximum Loss Potential: [(201 Short Put – $2.58) + $212.44 Share Purchase Price] x 100 = $41,086 (stock price at $0)

Let’s see what happens!

Covered Strangle #1 Trade Results

In the top half of the chart, you can see the stock price, short put and call strikes, and the covered strangle’s breakeven price. In this example, the stock price was relatively flat and was only a few points higher than the breakeven price at expiration.

In the bottom half of the chart, we can see the P/L performance of the covered strangle components (the green line represents the combined performance of the long shares and short strangle). In this example, the short strangle decayed steadily over time, and expired worthless at expiration. The long stock position ended up not making any money because the stock price was around $212.44 at expiration. However, the covered strangle made money overall because of the profits from the short strangle.

At expiration, this trader would not have to take any action to avoid assignment on the short options because the options are out-of-the-money. Additionally, this covered strangle trader would be able to sell another strangle in the next expiration cycle to collect more credit against their stock position.

Ok, so you’ve seen a slightly profitable covered strangle that breaks even. Next, we’ll look at a scenario where a covered strangle position realizes the maximum profit potential at expiration.

Maximum Profit Covered Strangle - Trade Example #2

In the following example, we’ll investigate a situation where the stock price rises continuosly after a hypothetical trader enters a covered strangle.

Here’s the setup:

Initial Share Purchase Price: $82.09

Strangle Strikes and Expiration: Short 95 Call; Short 67.5 Put; Both options expiring in 88 days

Premium Collected for Strangle: $2.54 for the call + $3.05 for the put = $5.59

Breakeven Price: $82.09 share purchase price – $5.59 strangle credit = $76.50

Maximum Profit Potential: ($95 short call strike – $76.50) x 100 = $1,850

Maximum Loss Potential: [(67.5 Short Put Strike – $5.59 Strangle Credit) + $82.09 Stock Purchase Price] x 100 = $14,400 (stock price at $0)

Let’s take a look:

Covered Strangle #2 Trade Results

In this example, we can see that the stock price surges from $82.09 to nearly $110 over the 88-day period the covered strangle was on. As a result, the long stock portion of the trade performed well, but the short strangle actually lost money. As a result, the long stock position performed the best, but the covered strangle wasn’t far behind.

At expiration, the short call would expire to -100 shares, which means the covered strangle trader would lose their long stock. If the trader wanted to keep their shares, the short call would need to be purchased back before expiration. However, it’s still possible that the trader is assigned early on the short call, so there’s no guarantee that the trader in this example would keep their shares.

Covered Strangle Gone Wrong - Trade Example #3

In the final example, we’ll look at a covered strangle trade that suffers significant losses due to a decrease in the stock price. Here’s the setup:

Initial Share Purchase Price: $636.98

Strangle Strikes and Expiration: Short 725 Call; Short 570 Put; Both options expiring in 74 days

Premium Collected for Strangle: $19.60 for the call + $13.92 for the put = $33.52

Breakeven Price: $636.98 share purchase price – $33.52 strangle credit = $603.46

Maximum Profit Potential: ($725 short call strike – $603.46) x 100 = $12,154

Maximum Loss Potential: [(570 Short Put Strike – $33.52 Strangle Credit) + $636.98 Share Purchase Price] x 100 = $117,346 (stock price at $0)

Let’s see what happens!

Covered Strangle #3 Trade Results

As we can see here, the stock price fell from $636.98 to below $500 in a very short period. Consequently, the covered strangle performed poorly because the strategy includes long stock and a short put, which are both bullish components. Later on in the period, the covered strangle ended up outperforming the long stock position because the short strangle ended up being profitable.

At expiration, this covered strangle trader would be assigned +100 shares of stock from the 570 put. If the trader wanted to avoid assignment, they would need to buy back the short put before expiration. However, keep in mind that the put was deep-in-the-money before expiration, so there’s always a possibility that the trader gets assigned early.

Final Word

Congratulations! You now know how the covered strangle works as a trading strategy!

Perhaps the most important thing to take away from this strategy is the great downside risk – you have both stock AND short put exposure should the underlying plummet.

Next Lesson

Additional Resources

Covered Strangle Covered Combination – The Options Education Organization

Covered Call Options Strategy: Complete Guide w/ Visuals

Posted on January 28, 2022March 22, 2022 by Chris Butler

Last updated on March 22nd, 2022 , 11:41 am

Covered call writing is an options trading strategy that consists of selling a call option while owning at least 100 shares of the stock. On a perfect 1:1 ratio, one call option can be sold for every 100 shares of stock that are owned.

By itself, selling a call option is a highly risky strategy with unlimited loss potential. However, when combined with a long stock position of 100 shares, selling a call option adds no additional risk, and creates a way to profit when the share price remains flat or even declines slightly.

Even more, the credit received for the call option provides downside protection against decreases in the stock price. The cost of this protection is that the long stock position’s potential profits are limited by selling the call.

In this post, you will learn the covered call strategy through in-depth examples and visualizations with real option data.

For those with smaller trading accounts, the poor man’s covered call is an alternative to covered calls that requires significantly less money to trade.

TAKEAWAYS

The covered call is an income generation strategy for equity owners who do not anticipate their stock will go higher in the future.
In order for the position to be “covered”, 100 shares of stock must be long for every call that is sold.
Most traders prefer selling “out-of-the-money” calls as these have a higher probability of expiring worthless.
Covered calls can be profitable in bearish, neutral, and even slightly bullish markets.
Maximum loss is high on this trade, as the stock still has downside risk.

Covered Call Writing - Strategy Characteristics

Let’s go over the strategy’s general characteristics:

➥Max Profit Potential: (Short Call Strike + Credit Received for Call – Share Purchase Price) x 100

➥Max Loss Potential: (Share Purchase Price – Credit Received for Call) x 100

➥Expiration Breakeven: Share Purchase Price – Credit Received for Call

➥Approximate Probability of Profit: Greater than 50%

To gain a better understanding of these concepts, let’s walk through a basic example.

Profit/Loss Potential at Expiration

In the following example, we’ll construct a covered call position from the following option chain:

Trade Details

In this case, let’s assume the stock price is trading for $75 at the time of these option quotes. To construct a covered call, we’ll first buy 100 shares of stock at $75 per share. Next, we’ll sell one of the call options from above. For this example, we’ll sell the 80 call.

Share Purchase Price: $75

Short Call Strike Sold: $80

Premium Collected for the 80 Call: $3.00

Here are this particular position’s characteristics:

Max Profit Potential:

($80 short strike + $3 credit received – $75 share purchase price) x 100 = $800

Max Loss Potential:

($75 share purchase price – $3 credit received) x 100 = $7,200 (stock price goes to $0)

Expiration Breakeven Price (Effective Share Purchase Price):

$75 share purchase price – $3 credit received = $72

Probability of Profit: Greater than 50%

Position if Assigned:

If assigned on the short 80 call, then the covered call writer is obligated to sell 100 shares of stock at the strike price. Since the trader already owns 100 shares, the assignment leaves the trader with no position. However, the bright side is that a being assigned results in maximum profit for the covered call writer.

The following visual demonstrates the potential profits and losses for this particular position at expiration:

Covered Call Outcomes

As you can see, buying 100 shares of stock at $75 and selling the 80 call for $3 reduces the risk of the position compared to just buying and holding stock. Since a credit is collected for selling the call, the purchase price of the shares is effectively reduced by the amount of the call price. Therefore, the breakeven price of a covered call position is essentially the reduced purchase price of the shares. However, for this purchase price reduction, the position’s potential profits are capped when the stock price rises above the strike price of the short call.

We’ve also added the profits and losses for a long stock position as a comparison. Compared to the long stock position, the covered call has less loss potential and more profit potential at most of the prices. However, if the stock price rises significantly above the short call strike, then the long stock position without a short call against it performs better. Because of this, a covered call writer is usually not extremely bullish on the stock.

Great job! You know the potential outcomes of a covered call position at expiration, but what about before expiration? As a demonstration, we’re going to look at a few positions that recently traded in the market.

Covered Call Trade Examples

In the following examples, we’ll compare changes in the stock price to a covered call position on that stock. Note that we won’t discuss the specific stock the trade was on, as the same concepts apply to each stock.

Covered Call vs. Holding Shares - Trade Example #1

First, let’s examine a situation where covered call writing is less lucrative than just buying and holding shares of stock. Here’s the setup:

Initial Share Purchase Price: $121.45

Strike Price and Expiration: Short 125 call expiring in 74 days

125 Call Sale Price: $1.41

Breakeven Stock Price (Effective Share Purchase Price):

$121.45 share purchase price – $1.41 credit received from call = $120.04

Maximum Profit Potential:

($125 short call strike – $120.04 effective share purchase price) x 100 = $496

Maximum Loss Potential:

$120.04 effective share purchase price x 100 = $12,004 (stock price goes to $0)

Purchasing 100 shares of stock for $121.45 per share and selling one of the 125 calls for $1.41 results in a breakeven price of $120.04. Because of this, the stock price can fall, and the covered call can still profit. However, for that protection, the profit on the long shares is capped. At expiration, any stock price above the short call strike of $125 will result in the same gain for the covered call writer.

With that said, let’s see what happens!

Covered Call #1 Trade Results

As illustrated here, the stock price rising above $132.50 results in profits of $1,250 for an investor who just bought and held 100 shares of stock.

On the other hand, the profit potential is limited for an investor who sold the 125 call against their shares. It doesn’t matter if the stock price is $125 or $1,000 at expiration, the profit on a covered call position with a short 125 call will be the same.

So, by selling a call against shares of stock, an investor gains the ability to profit when the stock stays flat or declines slightly. However, that benefit comes at the cost of profit potential on the long shares.

In this example, the maximum profit potential is achieved fairly early in the trade because the stock price traded significantly higher than the short call strike price. When maximum profit is achieved before expiration, it’s likely that the trader will close the position to lock in the profits. To close a covered call position, the trader can simultaneously sell the shares of stock and buy back the short call.

After expiration, this particular covered call writer would lose their shares if they held the short 125 call through expiration. To keep the shares, the investor would have to buy back the 125 short call at a loss, though the overall covered call position was profitable. Lastly, it’s important to note that the trader in this scenario faces an early assignment on the short call because the option is deep-in-the-money for most of the trade.

Next, we’ll look at an example of when covered call writing works out perfectly.

Income-Generating Covered Call - Trade Example #2

In the next example, we’ll look at a situation where the stock price remains in a particular range over 53 days. More specifically, the stock price is the same at the beginning and the end of the period. Over this time frame, we’ll compare a covered call position to a long stock position.

Here’s the setup:

Initial Share Purchase Price: $116.45

Strikes and Expiration: Short 120 call expiring in 53 days

120 Call Sale Price: $5.80

Breakeven Stock Price (Effective Share Purchase Price):

$116.45 share purchase price – $5.80 credit received from call = $110.65

Maximum Profit Potential:

($120 short call strike – $110.65 effective share purchase price) x 100 = $935

Maximum Loss Potential:

$110.65 effective share purchase price x 100 = $11,065 (stock price goes to $0)

This time around, we’re examining a covered call position where 100 shares of stock are purchased for $116.45 per share, and the 120 call is sold for $5.80. The breakeven price in this case is $110.65, which means the stock can fall $5.80 and the covered call writer will not lose money.

Let’s take a look at what happens:

Covered Call #2 Trade Results

The first thing to note about this trade is that the covered call position performs better than a long stock position when the shares remain below the short call’s strike price. This is because the profits from the short call offset losses (or add profits) when the stock price is below the short call’s strike price.

The second thing to note is that after expiration, this particular covered call writer would keep all the premium from selling the call, as the 120 call expires worthless. Since the 120 call was sold for $5.80, the covered call writer realizes a $580 profit when the call expires worthless (out-of-the-money). Additionally, when the short call expires out-of-the-money, a covered call writer keeps their long shares.

Lastly, you’ll notice that the long stock investor broke even on their position, as the stock price was the same at the beginning and the end of the period. However, the covered call writer made $580 from the premium collected on the call option. So, selling calls against long stock can be highly lucrative in a period of range-bound stock prices.

In the final example, we’ll look at a covered call position that is defensive in nature. While not profitable, we’ll see how the covered call compares to a long stock position.

A Defensive Covered Call - Trade Example #3

As mentioned throughout this guide, covered call writing provides protection against declines in the stock price. Because of this, covered calls can be used defensively. So, in the final example, we’ll look at a scenario where a covered call position is unprofitable but better off than just buying and holding stock.

Here are the specifics of the final example:

Initial Share Purchase Price: $119.99

Strikes and Expiration: Short 120 call expiring in 37 days

120 Call Sale Price: $2.58

Breakeven Stock Price (Effective Share Purchase Price):

$119.99 share purchase price – $2.58 credit received from call = $117.41

Maximum Profit Potential:

($120 short call strike – $117.41 effective share purchase price) x 100 = $259

Maximum Loss Potential:

$117.41 effective share purchase price x 100 = $11,741 (stock price goes to $0)

Let’s see what happens!

Covered Call #3 Trade Results

In this particular trade, the stock price fell sharply, resulting in losses for the covered call writer and the long stock investor. However, since the covered call writer collected $2.58 in premium, their loss was $258 less than the long stock investor at the expiration of the short call, demonstrating how a covered call can be used defensively.

Congratulations! You now know how the covered call strategy works! In the next section, we’ll discuss how to select which call to sell.

How to Select a Covered Call Strike Price

At this point, you know how covered calls work, as well as when you might use the strategy. However, with so many different call strikes available, how do you choose which one to sell? We’ve put together a simple guide that may help the strike price selection process easier.

Strike Price Selection: Determine Your Stock Price Outlook

Before selecting a call strike to sell, it’s crucial to determine an outlook for the shares of stock that you own. Here is a quick guide that demonstrates how to select a call strike based on various outlooks:

You Believe the Share Price Will Increase Significantly:

With such a bullish outlook, selling calls to limit the profit potential on the long shares might not make sense. Additionally, selling far-out-of-the-money calls doesn’t provide much profit potential or downside protection since far-out-of-the-money options are cheap.

You Believe the Share Price Will Increase Moderately:

Selling a call option with a delta between 0.20 – 0.30 may be logical, as those options only have a 20-30% probability of being in-the-money at expiration (in theory).

You Believe the Share Price Will Remain Flat/Decrease Slightly:

With a neutral outlook, selling calls with strike prices closer to the stock price (.40 to .50 delta calls) may be logical. Selling at-the-money calls provides the greatest profit potential from the decay of the call’s extrinsic value.

You Believe the Share Price Will Fall:

With such a bearish outlook, owning shares of stock or trading covered calls is likely not the appropriate strategy.

The table above serves as a guideline for selecting a call to sell. When trading covered calls, there isn’t a “one-size-fits-all” approach. The call that is sold depends on the investor’s outlook for the stock price in the future.

Final Word

Awesome! You’ve reached the end of the guide. Hopefully, you’re much more confident in your understanding of the covered call options strategy.

In a nutshell, we have learned:

Covered calls can help equity owners generate income in sideways markets.
The covered strategy only mildly reduces downside stock risk.
Before determining your strike price, it is important to determine the outlook for a stock.

Next Lesson

Supplemental Reading

Covered Strangle Covered Combination – The Options Education Organization

Bull Put Spread Example W/ Visuals – The Ultimate Guide

Posted on January 28, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 02:14 pm

A bull put spread is an options strategy that consists of selling a put option while also buying a put option at a lower strike price.

Both options must be in the same expiration cycle. Additionally, each strike should have the same number of contracts (i.e. if selling two puts, two puts at a lower strike should be bought). Selling put spreads is similar to selling naked puts, but far less risky due to buying a put against the short put. As the name suggests, a bull put spread is a bullish strategy, as it tends to profit when the underlying stock price rises.

TAKEAWAYS

Bull put spreads are best suited for bullish traders.
The bull put strategy is comprised of: 1.) buy a put at strike price A 2.) sell a put at strike price B.
The max profit for bull puts is the credit received.
Max loss in this strategy is the difference between strike A and strike B, minus the net premium received.
Breakeven for the bull put is strike B minus the net premium received when selling the spread.

Bull Put Spread Strategy Characteristics

Let’s go over the strategy’s general characteristics:

➥Max Profit Potential: Net Credit Received x 100

➥Max Loss Potential: (Width of Put Strikes – Credit Received) x 100

➥Expiration Breakeven: Short Put Strike – Credit Received

➥Other Known Aliases: Short Put Spread, Put Credit Spread

To gain a better understanding of each concept, let’s walk through a trade example.

Profits/Losses at Expiration for a Bull Put Spread

In the following example, we’ll construct a bull put spread from the following option chain:

Bull Put Construction

To construct a bull put spread, we’ll have to simultaneously sell one of these puts and purchase the same number of puts at a lower strike price. In this case, we’ll sell the 90 put and buy the 85 put. Let’s also assume that the stock price is $90 when selling the spread.

Initial Stock Price: $90

Short Put Strike: $90

Long Put Strike: $85

Premium Collected for the 90 Put: $5.09

Premium Paid for the 85 Put: $2.84

In this example, selling the 90 put for $5.09 and buying the 85 put for $2.84 results in a net credit received of $2.25 (since $5.09 is collected, and $2.84 is paid). Additionally, the “spread width” is the difference between the long and short put strike, which is $5 in this case. Based on a net credit of $2.25 on a $5-wide bull put spread, here are the position’s characteristics:

Max Profit Potential: $2.25 Credit x 100 = $225

Max Loss Potential: ($5-Wide Strikes – $2.25 Credit) x 100 = $275

Expiration Breakeven Price: $90 Short Put Strike – $2.25 Credit = $87.75

Probability of Profit:

This bull put spread example has a probability of profit slightly greater than 50% because the breakeven price is less than the initial stock price, which means the stock price can fall slightly and the position can still profit. Additionally, the maximum loss potential is greater than the maximum profit potential.

Position After Expiration

If the stock price is below 85 at expiration, both puts expire in-the-money. At expiration, an in-the-money long put expires to -100 shares, and an in-the-money short put expires to +100 shares, which nets out to no stock position for the put spread seller. If the stock price is between 90 and 85 at expiration, only the short put expires in-the-money, resulting in a position of +100 shares for the short put spread trader.

The following visual demonstrates the potential profits and losses for this bull put spread at expiration:

Bull Put Trade Results

Stock Price Above the Short Put Strike ($90):

Both the 85 and 90 put expire worthless. The profit on the short 90 put is $509, but the loss on the long 85 put is $284, resulting in a net profit of $225.

Stock Price Between the Short Put Strike ($90) and the Bull Put Spread’s Breakeven Price ($87.75):

The short 90 put expires with intrinsic value, but not more than the $2.25 credit received for the short put spread. Because of this, the bull put spread trader realizes a profit, but not the maximum profit since the position expires with some value.

Stock Price Between the Bull Put Spread’s Breakeven Price ($87.75) and the Long Put Strike ($85):

The short 90 put expires with more intrinsic value than the $2.25 credit the put spread trader collected when selling the spread. Because of this, the trader realizes a loss at expiration, but not the maximum loss.

Stock Price Below the Long Put Strike ($85):

The value of the $5-wide short put spread is $5. Since the spread was sold for $2.25, the trader realizes the maximum loss of $275.

Nice! You know how to determine the potential outcomes of a short put spread at expiration, but what about before expiration? To demonstrate how short put spreads perform before expiration, we’re going to look at a few examples of positions that recently traded in the market.

Bull Put Spread Trade Examples

In the following examples, we’ll compare changes in the stock price to a bull put spread on that stock. Note that we won’t discuss the specific stock the trade was on, as the same concepts regarding short put spreads apply to each stock. Additionally, each example represents one short put spread. The potential gains and losses scales proportionately to the number of put spreads traded.

Trade Example #1: Maximum Loss Bull Put Spread

The first example we’ll investigate is a situation where a trader sells an at-the-money put spread. An at-the-money bull put spread consists of selling an at-the-money put and buying an out-of-the-money put. When constructed properly, the breakeven price is slightly below the current stock price. Here’s the setup:

Initial Stock Price: $109.96

Strikes and Expiration: Short 110 put expiring in 46 days. Long 95 put expiring in 46 days.

Net Credit Received: $9.22 received for the 110 put – $3.67 paid for the 95 put = $5.55.

Breakeven Stock Price: $110 short put strike – $5.55 net credit received = $104.45.

Maximum Profit Potential: $5.55 net credit x 100 = $555.

Maximum Loss Potential: ($15-wide put strikes – $5.55 credit received) x 100 = $945.

Let’s see what happens!

Bull Put #1 Trade Results

As you can see here, the value of the put spread increases as the stock price falls, which is not good for a short put spread trader.

At expiration, both put strikes are in-the-money, which results in the maximum loss of $945 for the short put spread trader: ($5.55 sale price – $15 expiration price) x 100 = -$945. Since a short put expires to +100 shares and a long put expires to -100 shares, no stock position is taken if the trader holds the in-the-money spread through expiration. However, it’s possible that the short put spread trader gets assigned on the short 110 put when it’s in-the-money with little extrinsic value.

Next, we’ll look at an example of a trade where the stock price is below the short put at expiration, but the position is still profitable.

Trade Example #2: Partial Profit

In the next example, we’ll look at a situation where a trader sells an at-the-money put spread and does not realize the maximum profit potential.

Here’s the setup:

Initial Stock Price: $219.28

Strikes and Expiration: Short 220 put expiring in 49 days. Long 190 put expiring in 49 days.

Net Credit Received: $14.60 received for the 220 put – $4.60 paid for the 190 put = $10.

Breakeven Stock Price: $220 short put strike – $10 net credit received = $210.

Maximum Profit Potential: $10 net credit received x 100 = $1,000.

Maximum Loss Potential: ($30-wide put strikes – $10 credit received) x 100 = $2,000.

Let’s take a look:

Bull Put #2 Trade Results

As demonstrated here, the timing of the short put spread entry couldn’t have been worse. With just over 35 days to expiration, the put spread was trading for $20, which represents a $1,000 loss for a trader who sold the spread for $10.

However, since a short put spread has limited loss potential, let’s say the trader in this example held on to the position. Near expiration, the stock price rallied above the short put spread’s breakeven price of $210 and the put spread’s value fell. At expiration, the stock was trading for $217.11, which means the short 220 put was worth $2.89 and the 190 put was worthless. Since the trader sold the spread for $10, the expiration profit on the spread was $711: ($10 sale price – $2.89 expiration price) x 100 = +$711.

Alright, you’ve seen short put spread examples that break even and realize the maximum loss. In the final example, we’ll investigate a trade that winds up with its greatest profit potential.

Trade Example #3: Maximum Profit Put Spread

In the final example, we’ll examine a bull put spread example that ends up with its maximum profit potential.

Here are the specifics of the final example:

Initial Stock Price: $716.03

Strikes and Expiration: Short 700 put expiring in 67 days. Long 640 put expiring in 67 days.

Net Credit Received: $30.20 received for the 700 put – $12.15 paid for the 640 put = $18.05.

Breakeven Stock Price: $700 short put strike – $18.05 net credit received = $681.95.

Maximum Profit Potential: $18.05 net credit received x 100 = $1,805.

Maximum Loss Potential: $60-wide put strikes – 18.05 net credit received = $4,195.

Bull Put Spread #3 Trade Results

When the stock price rises significantly, the value of the put spread falls, which is great news for the put spread seller. In this example, there were plenty of opportunities for the trader to take profits before expiration. To close a bull put spread, the trader can simultaneously buy back the short put and sell the long put. As an example, let’s say the trader wanted to take profits when the spread’s price fell to $10. When the trader buys back the spread for $10, they lock in $805 in profits: ($18.05 initial spread sale price – $10.00 closing price) x 100 = +$805.

At expiration, the stock is trading for over $725, and both the 700 and 640 put expire worthless. The resulting gain on the short 700 put is $3,020 and the loss on the long 640 put is $1,205. Therefore, the net profit on the position is $1,805 for the put spread seller, which is the position’s maximum profit potential.

Final Word

Congratulations! You now know how short put spreads work as a trading strategy. Lastly, let’s go over what we learned:

In the short put spread, a trader wants BOTH options to expire worthless.
This occurs when both the long and short option are out-of-the-money on expiration
Time decay works to the advantage of short puts.

Next Lesson

Additional Resources

Bull Put Spread – Fidelity Investments

Short Put Option Strategy Explained – Guide w/ Visuals

Posted on January 28, 2022March 15, 2022 by Chris Butler

Last updated on March 15th, 2022 , 02:01 pm

Selling put options (sometimes referred to as being “short put options”) is an options trading strategy that consists of selling a put option on a stock that a trader believes will increase in price. The risk in this strategy can be great, so it is important have a solid understanding of this options strategy before placing your first short put trade. Let’s get started!

TAKEAWAYS

Selling puts is a high probability, high risk strategy for neutral to bullish traders.
In the short put, profit is limited to the total credit received.
Max loss in short puts is great and calculated by subtracting the credit received from the strike price.
The short put is ideal for investors who are willing and ready to purchase a stock should it fall to the strike price sold.

Short Put Strategy Characteristics

Let’s go over the strategy’s general characteristics:

•Max Profit Potential: Put Sale Price (Credit Received) x 100

•Max Loss Potential: (Put Strike Price – Credit Received) x 100

•Breakeven Price: Put Strike – Credit Received

To better understand these metrics, let’s go through a simple example.

Profit/Loss Potential at Expiration

In the following example, we’ll construct a short put from the following option chain:

In this case, let’s assume the stock price is $25 when entering the put position. For this trade, we’ll sell the 25 put for $2.00.

Stock Price: $25

Put Strike Price: $25

Put Sale Price: $2.00

The following visual describes the potential profits and losses at expiration for this short put position:

Short Put Trade Results

Stock Price Above the Put’s Strike Price (Above $25)

The put has no intrinsic value, and therefore expires worthless. In this case, the put seller realizes the maximum profit of $200.

Stock Price Between the Breakeven Price and the Put’s Strike Price ($23 to $25)

The put option expires with intrinsic value, but not more than the $2 credit the trader collected when selling the put. Consequently, the short put position is profitable.

Stock Price Below the Put’s Breakeven Price (Below $22)

The put option’s intrinsic value is now greater than the premium the trader collected when selling the put, and therefore the short put position is not profitable.

Stock Price at Zero

The company has gone out of business. Any short put traders will realize the maximum loss potential. For the seller of the 25 put, the loss will be $2,300: ($2 Put Sale Price – $25 Put Expiration Value) x 100 = -$2,300.

Short Puts = High Probability/High Risk

The last thing we’ll point out about this graph is that the breakeven price is below the current stock price. Because of this, selling puts is a high probability strategy. However, this makes sense since the maximum potential loss is greater than the maximum potential reward.

So, you know how the outcomes at expiration when selling puts, but what about before expiration? Understanding how profits and losses occur when selling put options can be explained by the position’s option Greeks (if you want to improve your understanding of the risks of your option positions, read our ultimate guides on the option Greeks).

Nice job! You’ve learned the general characteristics of the put selling strategy. Now, let’s go through some visual examples to solidify your knowledge of how short puts work.

Maximum Profit Short Put - Trade Example #1

To visualize the performance of selling put options, let’s look at a few examples of real puts that recently traded. Note that we don’t specify the underlying, since the same concepts apply to all stocks in the market.

The first example we’ll look at is a situation where a trader sells an at-the-money put option (strike price near the stock price). Here are the specifics:

Initial Stock Price: $147.23

Initial Implied Volatility: 43%

Put Strike and DTE: 150 put expiring in 37 days

Put Sale Price: $8.88

Put Breakeven Price: $150 short put strike – $8.88 credit received = $141.12

Maximum Profit Potential: $8.88 net credit x 100 = $888

Maximum Loss Potential: $141.12 breakeven price x 100 = $14,112 (stock price at $0)

Let’s see what happens!

Short Put Trade Results

As you can see, selling puts is profitable as long as the stock price doesn’t fall quickly and violently. You’ll notice that around 21 days to expiration, the stock price is trading right at the put’s strike price of $150, but the put is worth half of its initial value. Three factors contribute to the put’s price decrease:

1) 15 days have passed, resulting in the decay of the put’s extrinsic value

2) Implied volatility has fallen from 43% to 31% (not visualized by the graph), which indicates a broad decrease in the stock’s option prices.

3) The stock price has risen by $3, which results in lower put prices compared to before. Why? When the stock price increases, put options at every strike price become less valuable because they have a lower probability of expiring in-the-money.

Since short put positions have positive theta, negative vega and positive delta, they profit from the passage of time, decreasing implied volatility, and increasing stock prices. All three of these occurred in this trade example.

Regarding closing this position early, the trader in this example had many opportunities to close the put before expiration to lock in profits. To close a short put, a trader can buy back the put at its current price. As an example, if the trader in this example bought the put back when it was worth $3.00, they would lock in $588 in profits: ($8.88 initial sale price – $3.00 purchase price) x 100 = +$588. If held to expiration, the profit would have been $888 because the put expired worthless.

Next, we’ll look at an example of a short put trade where the stock price is below the put’s strike price at expiration.

Partially Profitable Short Put - Trade Example #2

When the stock price is below a short put’s strike price at expiration, the put seller will not make the full profit potential. However, it is still possible that the trade could work out. To demonstrate this, let’s look at an example where the stock price is trading below the short put’s strike price at expiration.

Here are the specifics:

Initial Stock Price: $673.86

Initial Implied Volatility: 30%

Strike and Expiration: 675 put expiring in 37 days

Put Sale Price: $24.52

Put Breakeven Price: $675 short put strike – $24.52 credit received = $650.48

Maximum Profit Potential: $24.52 credit received x 100 = $2,452

Maximum Loss Potential: $650.48 breakeven price x 100 = $65,048 (stock price at $0)

Let’s take a look at the trade’s performance:

Short Put #2 Trade Results

In this trade, the initial sale price of the 675 put was $24.52, resulting in a breakeven price of $650.48. Initially, the stock price crashed to nearly $640, which is well below the put’s breakeven price. As a result, the price of the 675 put surged to $42, which represents a $1,700 loss for the put seller.

However, the stock regained its losses and was trading around $665 at expiration. With the stock price $10 below the put’s strike price at expiration, the put was worth its intrinsic value of $10. Since the initial sale price was $24.52, the final profit is $1,452 per contract for the put seller: ($24.52 sale price – $10 expiration price) x 100 = +$1,452.

If the put seller let the put expire in-the-money, the resulting position would be +100 shares of stock. Letting an option expire in-the-money is known as “taking assignment.” In the case that the trader doesn’t want a stock position, the short put can be purchased back before expiration. However, keep in mind that it’s always possible to be assigned 100 shares of stock on an in-the-money short put, but unlikely when the put has plenty of extrinsic value.

Alright, you know how well short puts can do. Let’s finish by investigating what can go wrong when selling puts.

Significant Loss from Selling Puts - Trade Example #3

So, what happens when the stock price falls through the strike price of a short put? To demonstrate this, we’ll look at a situation where a trader sells an at-the-money put before the stock price drops significantly.

Here are the specifics of the next example:

Initial Stock Price: $109.99

Initial Implied Volatility: 27.5%

Strike and Expiration: 110 put expiring in 49 days

Put Sale Price: $4.20

Put Breakeven Price: $110 put strike price – $4.20 credit received = $105.80

Maximum Profit Potential: $4.20 credit received x 100 = $420

Maximum Loss Potential: $105.80 breakeven price x 100 = $10,580 (stock price at $0)

Let’s see what happens!

Short Put #3 Trade Results

In the first 14 days of this trade, the short put trader didn’t have significant profits or losses. However, things changed quickly when the stock price plummeted 10% after an earnings report.

With 21 days to expiration, the 110 put was worth $17, which is four times more than the initial sale price. At expiration, the stock price was $95, which meant the 110 put had $15 of intrinsic value. Unfortunately, this resulted in a loss of $1,080 per contract for the put seller: ($4.20 sale price – $15 expiration price) x 100 = -$1,080.

As mentioned earlier, it’s always possible to close the position early to lock in losses. For example, if this particular trader wanted to take their losses when the put traded $10, they could buy the put back and lock in $580 in losses: ($4.20 initial sale price – $10.00 purchase price) x 100 = -$580.

In summary, keep in mind that things don’t always work out when trading a high probability strategy such as selling puts. However, there’s always an exit opportunity if the losses get out of hand.

Final Word

Congratulations! You now know how selling put options works as a trading strategy. Be sure to revisit this guide often to solidify what you’ve learned.

In a nutshell, here is what we learned:

Short puts have great downside risk.
With decreasing extrinsic value, short puts have a greater chance of being assigned.
The maximum profit on short puts is limited to the credit received.
More premium can be collected from puts when the implied volatility is elevated

Next Lesson

Additional Resources

Explaining Put Options (Short and Long) – CME Group

Long Call Option Strategy for Beginners – Guide w/ Visuals

Posted on January 28, 2022February 10, 2022 by Mike Martin

Last updated on February 10th, 2022 , 02:19 pm

Long Call Option Characteristics

A long call option (when a trader buys a call option) is a bullish strategy that profits when the stock price increases quickly and significantly. Buying call options is the most aggressive way to trade a bullish stock price outlook.

In this guide, you’re going to learn everything you need to know about buying calls, and you’ll also see examples of when the strategy profits and loses money.

·Maximum Profit Potential: Unlimited

·Maximum Loss Potential: Premium Paid for the Call

·Expiration Breakeven Price: Call Strike + Premium Paid for Call

·Estimated Probability of Profit: Less Than 50%

·Assignment Risk?

Since the call owner has full control of exercising, there is no assignment risk. However, a call buyer should pay attention to the stock price near expiration. If the call expires in-the-money, the trader will end up with 100 shares of stock per call contract.

To better understand these metrics as they relate to buying call options, let’s go over a simple example.

If you’d prefer to watch the video, check it out below!

Long Call Profit & Loss Potential at Expiration

In the following example, we’ll construct a long call position from the following option chain:

In this case, let’s assume the stock price is trading for $100 and we purchase the 100 call:

Stock Price: $100

Call Strike Price: $100

Premium Paid for Call: $5

If a trader buys this call option, their potential profits and losses at expiration are described by the following chart:

Long Call Max Loss

In this scenario, the maximum loss is the premium the trader pays, which is $5 ($500 in actual dollar terms since one option contract represents 100 shares of stock). The maximum loss occurs when the stock price is below the strike price at expiration because the call will expire worthless. A call option has no value at expiration if the stock price is not above the call’s strike price.

Long Call Max Profit

Additionally, since a stock’s price has no upper limit, the potential profit for the call buyer is unlimited. However, with limited loss potential and unlimited profit potential, buying call options is a low probability strategy. This should make sense, as the stock price must increase more than 5% for any profits to be made at expiration (though profits can still be made before expiration if the stock price increases quickly).

So you know the outcomes for a long call position at expiration, but what happens before the option expires? Before expiration, understanding how profits and losses occur when buying call options can be explained by the strategy’s option Greeks (if you want to better understand the risks of your options positions, read our ultimate guides on the option Greeks).

Option Greek Exposures When Buying Calls

The following describes the option Greek exposures for a long call position:

Positive Delta – Call prices rise when the stock price increases, which benefits the call buyer. Conversely, call prices fall when the stock price decreases, which is not good for the call buyer.

Positive Gamma – A long call’s position delta gets closer to +100 as the stock price increases and closer to 0 as the stock price decreases.

Negative Theta – The extrinsic value of options decays as time passes, which is detrimental to a call buyer.

Positive Vega – Increases in implied volatility indicate an increase in option prices, which is beneficial to the call buyer. On the other hand, decreases in implied volatility indicate a decrease in option prices, which is harmful to a call owner.

When buying call options, a trader’s worst nightmare is the passage of time. To be profitable when buying calls, the stock price or implied volatility must increase to offset the losses from theta decay.

To understand this further, let’s look at some examples of call option trades.

Long Call Trade Examples

To visualize the performance of buying call options, let’s look at a few examples.

Trade Example #1: Call Option vs. Time Decay

The first example we’ll look at is a situation where a trader buys an at-the-money call option (strike price near the stock price). Here are the specifics:

Initial Stock Price: $105

Initial Implied Volatility: 30%

Call Strike and Expiration: 105 call expiring in 31 days

Call Purchase Price:$3.40

Call Breakeven Price: $105 call strike price + $3.40 debit paid for call = $108.40

Maximum Profit Potential: Unlimited

Maximum Loss Potential: $3.40 call purchase price x 100 = $340

Trade #1 Results

As we can see, the stock price never traded higher than the call’s breakeven price. At the same time, the stock price also never crashed significantly below the call’s strike price. As a result, the call option experienced a slow decay, leading to losses for the call buyer. In this specific example, the main drivers of the position’s losses were the passage of time (time/theta decay) and the stock price moving in the wrong direction (positive delta strategy but the stock price decreased).

However, there were still opportunities for the call trader to close the position for profits early in the trade. To close a long call position before expiration, a trader can simply sell the call option at its current price. As an example, if the trader sold the call when it was worth $4.50, they would have locked in $110 in profits: ($4.50 sale price – $3.40 initial purchase price) x 100 = +$110.

Trade Example #2: Call Option vs. Decreasing Stock Price

In this next example, we’ll look at a situation where a trader buys an in-the-money call option (strike price below the stock price). Traders buy in-the-money call options to increase the amount of directional exposure they have (as in-the-money calls have deltas closer to +1). Additionally, since the option’s price is mostly intrinsic, the effects of theta decay are minimal.

Here are the specifics:

Initial Stock Price: $201.02

Initial Implied Volatility: 21%

Call Strike and Expiration: 190 call expiring in 46 days

Initial Call Delta:+0.75

Call Purchase Price:$13.38

Call Breakeven Price: $190 call strike price + $13.38 debit paid for call = $203.38

Maximum Profit Potential: Unlimited

Maximum Loss Potential: $13.38 call purchase price x 100 = $1,338

Trade #2 Results

With an initial delta of +0.75, the 190 call option was expected to lose $0.75 for each $1 decrease in the stock price, which explains why the position performed so poorly when the stock price fell from $201 to $185. Over the same period, implied volatility increased from 21% to 28%. Unfortunately, that wasn’t enough to offset the losses from the decrease in the stock price.

From a probabilistic perspective, the decline in the call option’s price makes sense. With the stock price at $200, the probability of the 190 call expiring in-the-money was approximately 75% (based on a delta of 0.75). However, as the stock price fell to $185, the 190 call’s price fell because the likelihood of expiring in-the-money diminished.

As mentioned previously, a call option can always be closed before expiration. As an example, let’s say the trader in this example wanted to cut their losses when the call traded down to $10. If the trader sold the call for $10, they would have locked in losses of $338: ($10 sale price – $13.38 purchase price) x 100 = -$338.

At expiration, the stock was trading around $192, and the 190 call was worth its intrinsic value of $2.00. With an initial purchase price of $13.38, the resulting loss is $1,138 per contract for the call buyer. If the trader held the call through expiration, the resulting position would be +100 shares of stock per contract. The effective purchase price of these shares would be $203.38, which is the call’s strike price of $190 plus the $13.38 purchase price of the option.

Alright, you’ve seen what can go wrong when buying calls. Let’s finish by investigating what needs to happen to profit when buying call options.

Trade Example #3: Profitable Call Purchase

So, what exactly needs to happen to profit from a long call position? As discussed earlier, the stock price needs to rise to offset losses from time decay. To demonstrate this, we’ll look at a situation where a trader buys an at-the-money call before the stock price rises significantly.

Here are the specifics of the next example:

Initial Stock Price: $94.02

Initial Implied Volatility: 31%

Strike and Expiration: 92.5 call expiring in 42 days

Call Purchase Price:$4.65

Call Breakeven Price: $92.5 call strike price + $4.65 call purchase price = $97.15

Maximum Profit Potential: Unlimited

Maximum Loss Potential: $4.65 call purchase price x 100 = $465

Trade #3 Results

The first important note about this visual is that the stock price rose from $94 to around $97 in the first 24 days. However, the position still wasn’t very profitable because the increase wasn’t fast enough to offset losses from time decay.

Luckily, at around 18 days to expiration, the stock price rises more than 5% in the following week. Consequently, the 92.5 call buyer experienced healthy profits. At the time of expiration, the stock was trading for $105.85, and the call was worth its intrinsic value of $13.35. With an initial purchase price of $4.65, the resulting profit in this case was $870 per contract for the call buyer.

In this example, buying a call option was a home run trade. However, such a position requires the timing of an unexpectedly large move in the correct direction, which is very unlikely.

Final Word

Congratulations! You’ve reached the end of the guide. By now, you should have a pretty good understanding of how buying calls works and what needs to happen to make money when doing so.