Exotic Option Strategies
- The stock market can be unpredictable and certain option strategies take advantage of that unpredictability.stock market analysis screenshot image by .shock from Fotolia.com
Options trading is a versatile investment alternative for investors' portfolios. Options trading involves buying and selling calls and puts. Calls are the right to buy a stock at a set price for a specified time period, while puts are the right to sell a stock for a set price during a specified time period. Trading options provides an investor with increased leverage due to the fact that each option contract gives the right to buy or sell 100 shares of stock and costs a fraction of the price compared to buying shares of stock. This also leads to increased risk as options fluctuate at a much higher percent than the price of the stock. - A bull call spread is an exotic option strategy used when an investor believes the price of an underlying stock will increase. It involves buying in-the-money call options and simultaneously selling the same number of out-of-the-money call options. The same number of contracts must be bought and sold for the same expiration month for a bull call spread. This option strategy provides the investor with limited upside profits and downside losses.
- Another bullish option strategy is a bull calendar spread. This strategy is set up by selling near-term out-of-the-money call options and buying longer-term out-of-the-money call options. To execute this strategy, the investor must buy and sell the same number of contracts with the same strike price. A bull calendar spread provides the investor with unlimited upside potential with limited loss.
- A butterfly is an neutral option strategy that is used when an investor expects little movement in the price of the underlying stock. This complex strategy requires buying one in-the-money call, selling two at-the-money calls, and buying one out-of-the-money call. This exotic option strategy creates limited profit and loss, with the greatest profit coming if the stock price does not change.
- A straddle is an exotic option strategy that profits from volatility in the price of a stock, either up or down. There is unlimited profit potential with this strategy as the price of the stock moves farther from the price where the option was initiated. On the flip side, this option strategy has limited loss. To enter a straddle, an investor buy both at-the-money calls and puts simultaneously. If the stock moves rapidly and sharply in either direction, the profit from one of the trades will far exceed the loss from the other.
- A bear put spread is the opposite option strategy of the bull call spread. It is used when an investor is bearish on a stock. To enter a bear put spread, an investor buys in-the-money puts while selling the same number of out-of-the-money puts. Like a bull call spread, there are limited profits and losses.
