Neutral Options Strategies

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Chapter 26 — Neutral Options Strategies
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Neutral Options Strategies

Neutral options strategies are the opposite of volatility strategies. Neutral strategies are an attempt to profit from when a stock price doesn’t move at all! This can be a tricky trade to pull off, but neutral strategies can bring consistent returns if they are done correctly.

i. Covered Call

A covered call, also known as a covered buy call or covered call write, is a classic options strategy. It is similar to the naked call, but instead of writing the option on a security that you don’t own, you are writing an out of the money option on a security that you already own. This allows you to make a monthly income on the stock when you do not expect the price to increase.

The covered call has a limited amount of profit. The maximum amount you can make is the premium for the options contract that you write. You cannot technically lose money by writing covered call options, but you can still lose money overall if the price of your stock falls far enough. On the other side, if the price of the security rises, you will be unable to capture the gains from price increase because you have contracted them to the buyer of your call options.

ii. Covered Put

The covered put strategy is a more risky and more expensive version of the covered call strategy. In a covered put, you short the shares of stock, and then write an out of the money put option. The trade will then take on the opposite profit profile from a covered call. When the stock falls, your profit is limited to the difference between your shorted price and the strike price of the put contract. When the stock price rises, your losses can be unlimited, just like shorting the stock alone.

This strategy is rarely used by traders because it is so risky and expensive. Most options traders use less risky strategies to capture the same results. However, short sale investors sometimes use covered puts to give them some breathing room for short investments that temporarily move against them.

iii. Short Straddle

The short straddle is a trading strategy that profits when a stock price doesn’t move. It is the exact opposite of the long straddle strategy. You execute this strategy by writing a call option and a put option with the same on the money strike price and the same expiration date. If the price of the underlying stock does not move, you will profit from the premiums of both options. Your potential profits are limited to the value of these premiums, but if the price moves significantly in either direction, your potential losses can be unlimited.

iv. Short Strangle

The short strangle is similar to the short straddle and is the opposite from a long straddle. It involves selling a put and a call that have the same expiration but different strike prices. This is less risky than the short straddle because it gives you a wider trading range for the stock. As long as the stock stays within that range you will make money. And like the short straddle, your profits are limited while losses can be unlimited.