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Dr. Edward Olmstead, Professor, Northwestern University Chief Options Strategist, Dr. Olmstead’s Options Trading Strategies The option strategies discussed here extend the discussion on covered calls, initiated in our article on Covered Calls posted last week. They present ways to enhance or recapture a return on stock you already own (underlying position), even if that stock is showing a loss in your portfolio. The stock enhancement strategy can be used to greatly improve the return on a stock that you own. This is an options strategy that can be implemented at no additional cost beyond the original expense stock ownership. It also has no margin requirement and hence can be done in a retirement account. This strategy can be viewed as an extension of the covered call concept, although the motivation and time frame for the trade are unlike that of the typical covered call. The same strategy can be used to accelerate the recovery in value of a stock that has suffered a significant drawdown. In this case the strategy is known as the stock repair strategy. Again, it is a no cost trade. Stock Enhancement Strategy For this strategy to work, it is necessary for your stock to make some reasonable gain over the next 5-6 months. This strategy is intended to convert a reasonable profit in the stock into an excellent overall return at no cost beyond what you paid for the stock. For each 100 shares of stock, the basic plan is to sell one out-of-the-money call with a strike price at the level you expect the stock to reach in 5-6 months. This combination is just a covered call trade, except that it goes much further out in time than you would expect with a typical covered call. Next, you use the proceeds from the sale of the covered call to pay for a one contract bull call spread. The upper strike for the bull call spread will be the same as the covered call, while the lower strike for the spread will be nearer the current price of the stock. Let's look at an example to illustrate the stock enhancement strategy: Example: Many analysts are forecasting significant gains in the prices of copper and gold over the next 5-6 months. A good way to play this forecast is to buy Freeport McMoran (FCX), a strong company that specializes in both metals. To boost the return in this investment, the Stock Enhancement Strategy can be employed. Trade: Buy 100 shares of FCX at $35.50 per share. Buy 1 Nov. 37 call for $2.3 per share and sell 2 Nov. 40 calls for $1.20 per share. The option transactions actually produce a net credit of $.10 per share to help pay for your commissions. Position: This holding can be viewed as a covered call (long 100 shares FCX and short 1 Nov. 40 call) and a bull call spread (long 1 Nov. 37 call and short 1 Nov. 40 call). Payoff: If FCX is above $40 at the November options expiration, the stock will be called away at $40 for a $4.5 per share gain over its purchase price. The bull call spread will be worth $3 per share. The total gain of $7.5 per share represents an excellent return of 21.1% on a stock that only needed to move up by 12.6%. Comment: Remember that this is a no-cost trade. If FCX does not reach $40 by the November expiration, the Nov. 37 call will still provide a profit if the stock price exceeds $37. An additional bonus on this particular trade is that FCX pays a nice annual dividend of which about half can be captured over the next 5 months. Stock Repair Strategy Using the same approach as the stock enhancement strategy, it is possible to recover the full value of a stock whose price has suffered a large pullback. For the repair strategy to be effective, it is necessary for the stock to make some modest gain in the next 3-4 months. Let’s look at an example to illustrate the stock repair strategy: Example: Those who bought 100 shares of Facebook Inc. (FB) at $38 per share during its IPO in May are now looking at a deflated price of $31.70 in mid-June. With a modest increase in the price of FB over the next 3 months, the Stock Repair Strategy can more than make up for the lost value. Trade: For each 100 shares you own, buy 1 Sept 32 call for $3.2 per share and sell 2 Sept 36 calls for $1.6 per share. This is a no cost trade. Position: This holding can be viewed as a covered call (long 100 shares FB and short 1 Sept 36 call) and a bull call spread (long 1 Sept 32 call and short 1 Sept 36 call). Payoff: If FB is above $36 at the September options expiration, the stock will be called away at $36 for a $4.3 per share gain over its mid-June price of $31.70. The bull call spread will be worth $4 per share. The total gain of $8.3 per share represents an equivalent stock price of $40.00, which is $2.0 per share better than the original purchase price. Comment: Remember that this is a no-cost trade. If FB only reaches $35 by the September expiration, the Sept 36 calls will expire worthless and the Sept 32 call will still provide enough profit to effectively raise the stock value back to its original price of $38. Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.

Dr. Edward Olmstead, Professor, Northwestern University Chief Options Strategist, Dr. Olmstead’s Options Trading Strategies One of the first strategies that someone new to options hears about is the covered call trade. Frequently, this strategy is touted as a safe and simple way to make money with options. Many brokerage firms allow covered calls as the only options trade that can be made in a retirement account because it is “conservative.” Unfortunately, this description of covered call trades as conservative is highly misleading. Ask those same brokers who only allow covered call trades in retirement accounts how they feel about selling naked puts. They will explain how that type of trade is much too risky to be allowed in a retirement account. Well, at least they got that part correct ---- selling naked puts does involve significant risk. The truth is that a covered call trade has exactly the same risk and reward characteristics as selling a naked put. More about this later. In its simplest form, the covered call trade requires that you own 100 shares of stock. Then you can sell one call option contract with a strike price that is above the current stock price. In this situation, the call that you sold is said to be “covered” by the stock that you own. If it happens that the option is exercised, your brokerage account possesses the stock that must be made available for sale at the strike price. The cash received from selling the call is yours to keep no matter what happens. Here is the idealized description of what happens when the call option expires. If the stock price is above the strike price of the call at expiration, your stock will be called away for a price that is presumably higher than your original purchase price ---- you have made a profit on the price increase in the stock and you also have the cash received from the selling the option. If the stock price is below the strike price of the option at expiration, then the option expires worthless and you keep your stock ---- you again have the cash received from selling the option, and you are free to repeat the process by selling another call in the next option cycle. As you can see in this idealized version, the covered call trade has the potential to generate regular profits by repeatedly selling call options against stock that you own. Unfortunately, the covered call trade is not nearly as straightforward as the idealized description would suggest. Stock prices undergo considerable fluctuation over time and, all too frequently, the stock price on the expiration date will be either well above or well below the strike price of the short call. Both scenarios present a difficult decision going forward. If the stock price is much higher than the strike price of the call at expiration, you may be reluctant to give up your stock at a price that is well below its current level, and thus forego any future gains in the stock price. The only alternative is to buy back the short call for a significant loss in order to continue holding the stock. If the stock then fails to perform as expected, it may be quite difficult to make up for the loss incurred from buying back the short call. If the stock price is much lower than the strike price of the call at expiration, you keep the stock, but you are faced with the challenging decision of which call strike to sell for the next option cycle. If you sell a high strike in order to give the stock price room to move up, the cash received from the sale may be miniscule. On the other hand, if you sell a strike nearer to the current stock price in order to receive more cash, you lose the opportunity for the stock to regain all of its lost value. Now let’s get back to comparing a covered call with selling a naked put. To see that these two trades have the exactly the same risk and reward characteristics, examine cases in which the stock price at expiration is either above or below the strike price of the option. To make things definite, consider a specific example. Covered call: With XYZ at $53, you buy 100 shares of stock and sell one 55 call option for $2.0 per share. This means that you have equivalently purchased 100 shares of XYZ for $51 per share. If the XYZ has fallen to $40 per share at options expiration, you will have lost $1100 on this trade. The maximum reward that you can receive on this trade is $400, which occurs when the stock price exceeds $55 at expiration. Naked put: With XYZ at $53, you sell one 55 put option for $4.0 per share, which pays you $400. If XYZ has fallen to $40 per share at options expiration, the option will be exercised and you will be required to buy the stock for $55 per share. Subtract the $400 you received and your loss on this trade will be $1100. The maximum reward occurs when the stock price exceeds $55 at expiration and you get to keep the $400 received from the sale of the put. If you are going to do covered call trades, then be aware that it is not a conservative trade and be prepared to make a challenging decision when the options expiration date arrives. Here are some suggestions for handling covered call trades: 1. Since almost all of your risk is in what you paid for the stock, focus your attention on the stock price and to a much lesser extent on the option price. Decide on an appropriate stop loss price for the stock, and if it falls to that level, protect the major portion of your investment by selling the stock and buying back the call. Do not hang onto to a falling stock in order to collect an extra $.50 per share from the short option. 2. When deciding upon the strike price of the call that you are going to sell, make sure it is a price at which you will feel comfortable in giving up your stock if necessary. If your goal is to keep your stock under all circumstances, then select a higher strike price. If you are willing to sell your stock closer to its current value, then pick a nearby strike price to bring in more cash. 3. Do not sell a call with an expiration date too far out in time. Those juicy premiums in the longer-term options are tempting, but you will generally do better by selling the front month call. In today’s volatile market, a stock can have big moves (up or down) in 4-8 weeks. By selling near term options, you will be better placed to make an adjustment when the expiration date arrives. 4. Do not be greedy. If the stock price is above the strike price at expiration, take your profit and move on to a new trade. Avoid buying back the option for a loss unless you have a very compelling reason to do so. If you buy back the option for a loss and then the stock price subsequently collapses, you will have compounded a loss on the option with a loss on the stock. ### Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com

Traders who implement a conversion strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves selling and purchasing a put and a call option, at-the-money, while going long on the underlying asset. Traders can earn a small, risk-free profit when converting options, as long as the option's strike prices exceed the prices of the associated underlying asset. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How to Carry Out A Conversion Strategy Disney stock is worth $100 (market price) in June. 1) Trader buys 100 shares of Disney stock. 2) Trader buys the put option: DISJul100($3) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $3 3) Trader sell the call option: DISJul100($4) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $4 4) Trader pays $9900 to enter the conversion. [$9900 (paid for shares) + $400 (received from call) - $300 (paid for put)] Total cost to enter the market: $9900 Result one: Disney stock rises (rallies) to $110 in July. a) The put option purchased expires worthless. (OTM) b) The call option sold expires ITM. c) The investor who bought the trader's call option exercises his or her right to buy 100 shares at $100. d) The trader uses the 100 shares to cover the assignment and receives $10000 from the buyer. e) Trader gains a total of $100 after the subtracting the cost to enter the market from the funds collected from the call option. [$10000 (received from call buyer) - $9900 (cost to enter market)] Result two: Disney stock falls to $90 in July. a) The call option sold expires worthless. (OTM) b) The put option purchased expires ITM. c) The trader exercises his or her right to sell 100 shares at $100, receiving $10000 from the buyer for the long shares purchased when entering the trade. d) The trader's profit totals $100 after the subtracting the cost to enter the market from the funds collected from the put option. [$10000 (received from put seller) - $9900 (cost to enter market)] Calculating The Risk-Free Profit In A Conversion Investors earn instant profits when correctly entering a conversion trade. Market conditions will not matter at the time of expiration, as the synthetic long position covers losses and cancels gains on the long trade. In order to achieve instant profits, the options' strike prices must exceed the difference in the price of the underlying asset less the cost to enter the market. [$100 = $100 (options' strike prices) - $100 (cost to enter market) + $100 (asset price)] Advantages and Disadvantages of Implementing a Conversion : Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just converting the overpriced options to fair market value. Minuses: There is no downside in carrying out a reversal strategy, since it risk-free. However, traders must be able to recognize overpriced options of which values are higher than their associated underlying asset.

Traders who implement a box spread or long box strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves simultaneously entering a bull call and a bear put spread, using options with parallel strike prices. Traders can earn risk-free profit, as long as the expiration value of the box exceeds the cost to enter the spread.Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options: At-The-Money (ATM) Strike Price (equals) Market Price How To Set Up A Box Spread Strategy Disney stock is worth $45 (market price) in June. Entering the Bull Call Spread 1) The trader writes (sells) a call option: DISJan50($1) - 100 shares of Disney stock - Strike Price $50 (OTM), expiring in 30 days - Premium Cost of $1 2) The trader buys a call option: DISJan40($6) - 100 shares of Disney stock - Strike Price $40 (ITM), expiring in 30 days - Premium Cost of $6 3) The trader pays a total of $500 to enter the bull call spread [$600 (paid for call purchase) - $100 (received from call sale)] Entering the Bear Put Spread 1) Trader writes (sells) a put option: DISJan40($1.50) - 100 shares of Disney stock - Strike Price $40 (OTM), expiring in 30 days - Premium Cost of $1.50 2) Trader buys a put option: DISJan50($6) - 100 shares of Disney stock - Strike Price $50 (ITM), expiring in 30 days - Premium Cost of $6 3) The trader pays a total of $450 to enter the bull call spread [$600 (paid for call purchase) - $150 (received from call sale)] Total cost to enter the market (Box Spread Strategy): $950 [$500 (cost of bull spread) + $150 (cost of bear spread)] Computing Expiration Value To earn risk-free profit, the expiration value of the box must exceed the cost to enter the box spread. The expiration value is simply the difference between the higher and lower strike prices, multiplied by 100. This example's box spread expiration value is $1000 [$1000= $50 (high) -$40 (low) X 100], which is higher than the $950 cost to enter the market. Result one: Disney stays at $45 (ATM) in July. a) Both the put and call options sold expire worthless (OTM). b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller. c) The put option purchased is ITM. The trader exercises his or her right to sell the 100 shares at $50, receives $5000 from the seller. d) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)] Result two: Disney rallies to $50 in July. a) Both the put and call options sold expire worthless (OTM). b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller. c) The put option purchased is ITM. The trader exercises his or her right to sell the 100 shares at $50, receives $5000 from the seller d) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)] e) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from put sale) - $4000 (paid to call seller) - $950 (cost to enter market)] Result three: Disney falls (crashes) to $40 in July. a) The put and call options sold expire worthless (OTM), as well as the call option purchased. b) The put option purchased is ITM. c) The trader buys 100 Disney shares in the open market, paying $4000 d) The trader sells the 100 shares to the writer at $50, receiving $5000 from the seller. e) The trader's profit is $50 after subtracting the cost to enter the market from the gain. [$50 = $5000 (received from writer) - $4000 (paid for shares) - $950 (cost to enter market)] Advantages and Disadvantages of Implementing a Box Spread Strategy: Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just settling the overpriced options to fair market value. Minuses: There is no downside in carrying out a box spread strategy, since it risk-free. However, traders must be able to quickly recognize options with expiration values that exceed the investment's costs.

Traders who implement a reversal strategy are taking advantage of under priced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves selling and purchasing a put and a call option, at-the-money, while short selling the underlying asset. Traders can earn a small, risk-free profit when using a reversal strategy, as long as the two under priced option's values are lower than their associated underlying asset. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How to Carry Out A Reversal Strategy Disney stock is worth $100 (market price) in June. 1) Trader short sells 100 shares of Disney stock. 2) Trader sells the put option: DISJul100($4) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $4 3) Trader buys the call option: DISJul100($3) - 100 shares of Disney stock - Strike Price $100, at-the-money (ATM), expiring in 30 days - Premium Cost of $3 4) Trader receives a $10100 credit when entering the market. [$10000 (received from short sale) + $400 (received from put) - $300 (paid for call)] Total cost to enter the market: -$10100 Result one: Disney stock rises (rallies) to $110 in July a) The put option sold expires worthless. (OTM) b) The call option purchased expires ITM. c) The trader exercises his or her right to buy 100 shares at $100, paying 10000 to the seller. d) The trader uses the 100 shares to cover the short sale. e) Trader gains a total of $100 after keeping the remainder of the credit earned when entering the market. [$10100 (credit) - $10000 (paid for shares] Result two: Disney stock falls to $90 in July. a) The call option purchased expires worthless. (OTM) b) The put option sold expires ITM. c) The investor who bought the trader's put option exercises his or her right to sell 100 shares at $100. The trader pays $10000 to the buyer, and receives 100 Disney shares. d) The trader uses the 100 shares to cover the short sale. e) The trader makes a total profit of $100 after keeping the remainder of the credit earned when entering the market. [$10100 (credit) - $10000 (paid to cover put)] Calculating The Risk Free Profit In A Reversal Strategy Investors earn instant profits when correctly entering a reversal trade. Market conditions will not matter at the time of expiration, as the synthetic long stock position covers losses and cancels gains on the short sale. In order to achieve instant profits, the price of the underlying asset must exceed the difference in premiums collected less the options' strike prices. [$100 = $100 (asset price) + $100 (premium credit) - $100 (options' strike prices)] Advantages and Disadvantages of Implementing a Reversal Strategy: Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just arbitraging the under priced options to fair market value. Minuses: There is no downside in carrying out a reversal strategy, since it risk-free. However, traders must be able to recognize under priced options of which values are lower than their associated underlying asset.

Traders who implement a short box strategy are taking advantage of overpriced assets by instantly liquidating (arbitraging) them to fair market value. The technique involves selling both a bull call and bear put spread at the same time, using options with parallel strike prices and expirations. Traders can earn risk-free profit, as long as the credit received when entering the market exceeds the expiration value of the box. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How To Set Up A Short Box Strategy Disney stock is worth $55 (market price) in July. Selling the Bull Call Spread 1) The trader writes (sells) a call option: DISAug50($7) - 100 shares of Disney stock - Strike Price $50 (ITM), expiring in 30 days - Premium Cost of $7 2) The trader buys a call option: DISAug60($1.50) - 100 shares of Disney stock - Strike Price $60 (OTM), expiring in 30 days - Premium Cost of $1.50 3) The trader receives a credit of $550 when entering the bull call spread. [$700 (received from call sale) - $150 (paid for call purchase)] Selling the Bear Put Spread 1) Trader writes (sells) a put option: DISAug60($7) - 100 shares of Disney stock - Strike Price $60 (ITM), expiring in 30 days - Premium Cost of $7 2) Trader buys a put option: DISAug50($2) - 100 shares of Disney stock - Strike Price $50 (OTM), expiring in 30 days - Premium Cost of $2 3) The trader receives a credit of $500 when entering the bear put spread. [$700 (received from put sale) - $200 (paid for put purchase)] Total (Short Box) credit when entering the market $1050: [$550 (credit from bull spread) + $500 (credit from bear spread)] Computing Expiration Value To earn risk-free profit, the credit received when entering the market must exceed the expiration value of the box. The expiration value is simply the difference between the higher and lower strike prices, multiplied by 100. This example's box spread expiration value is $1000 [$1000= $60 (high) - $50 (low) X 100], which is lower than the $1050 credit when entering the market. Result one: Disney stays at $55 (ATM) in August. a) Both the put and call options purchased expire worthless (OTM). b) The put option sold is ITM The buyer exercises his or her right to sell the trader 100 shares at $60. The trader pays $6000 to the seller. c) The call option sold is ITM. The buyer exercises his or her right to buy shares at $50 from the trader, who sells the 100 shares and receives $5000 from the buyer. d) The trader's profit is $50 after adding the credit received when entering the market from the loss. [$50 = $5000 (received from call buyer) - $6000 (paid to put buyer) + $1050 (credit)] Result two: Disney rallies to $60 in August. a) Both the put and call options purchased and the put option sold expire worthless (OTM). b) The call option sold is ITM. c) The trader buys 100 Disney shares in the open market to cover the sale, paying $6000. d) The buyer exercises his or her right to buy shares at $50 from the trader, who sells the 100 shares and receives $5000 from the buyer. e) The trader's profit is $50 after adding the credit received when entering the market from the loss. [$50 = $5000 (received from call buyer) - $6000 (paid for shares) + $1050 (credit)] Result three: Disney falls (crashes) to $50 in August. a) Both the put and call options purchased and the call option sold expire worthless (OTM). b) The put option sold is ITM. c) The buyer exercises his or her right to sell the trader 100 shares at $60. The trader pays $6000 to the seller. d) The trader sells 100 Disney shares in the open market at $50 and receives $5000. e) The trader's profit is $50 after adding the credit received when entering the market from the loss. [$50 = $5000 (received from put buyer) - $6000 (share sale) + $1050 (credit)] Advantages and Disadvantages of Implementing a Small Box Strategy: Pluses: The upside to this type of strategy is that the investor will always make a small profit in any market situation, risk-free. The trader is just arbitraging the overpriced options to fair market value. Minuses: There is no downside in carrying out a short strategy, since it risk-free. However, traders must be able to quickly recognize options with overpriced expiration values.

A trader who implements a synthetic short stock (split strikes) is betting that an asset's value will fall. The technique involves buying the same number of call and put options for an underlying asset with the same expiration. Both the profit potential and the risk involved when using this strategy is unlimited. An investor who enters a synthetic short stock (split strikes) strategy can gain large profits if the market crashes but can also incur big losses if it rallies. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike Price (less than) Market Price Out-of-The Money (OTM) = Strike Price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price = (equals) Market Price How to Implement a Synthetic Short Stock (Split Strikes) Strategy Disney stock is worth $40 (market price) in June. 1) Trader sells a call option: DISJul45($1) - 100 shares of DIS stock - Strike Price $45, out-of-the-money (OTM), expiring in 30 days - Premium Cost of $1.00 2) Trader buys a put option: DISJul35($0.50) - 100 shares of DIS stock - Strike Price $35, out-of-the-money (OTM), expiring in 30 days - Premium Cost of $1.00 3) The trader receives a $50 credit when entering the market. [$100 (received from sale) - $50 (paid for put)] Total cost to enter the market: -$50 Result one: Disney stock falls (moderately) to $35 in July. a) The call sold option expires worthless. (OTM) b) The put option purchased expires worthless. (OTM) c) The trader gains a total of $50 after keeping credit taken when entering the market. Result two: Disney stock rises (rallies) to $60 in July. a) The put option expires worthless. (OTM) b) The call option sold expires ITM. The investor who bought the trader's call option exercises his or her right to buy 100 shares at $45. c) The trader buys 100 Disney shares in the open market, paying $6000. d) He or she then sells them to the buyer, receiving $4500. e) The trader loses a total of $1450 after subtracting the premium credit taken when entering the market. [$1450 = $50 (credit to enter market) - $1500 (loss from call)] Result three: Disney stock falls (crashes) to $20 a) The call option expires worthless. (OTM) b) The put option expires ITM, so the trader buys 100 Disney shares in the open market, paying $2000 to cover the sale. c) The trader exercises his or her right to sell the 100 shares at $35 to the writer and receives $3500 from the seller. d) The trader gains a total of $1550 after adding the premium credit taken when entering the market. [$1550 = $1500 (profit from put) + $50 (credit to enter market)] Advantages and Disadvantages of Implementing a Synthetic Short Stock (Split Strikes): Pluses: The upside to this type of strategy is that the investor will always make a profit in a bear market, which can lead to unlimited profit potential if prices crash. The trader also can enter the market without paying cash. He or she receives a premium credit, keeping it when the index call option expires worthless, and using the credit to offset losses, if the asset's value rises. Minuses: The downside in using a synthetic short stock (split strikes) is that the method exposes the investor to unlimited risk. If the underlying asset's market value rallies, then he or she can lose large amounts of money, since an asset's price can theoretically rise as much as the demand permits.

A trader who implements a synthetic short stock strategy is betting that an asset's value will fall. The technique involves buying the same number of call and put options for an underlying asset. The profit potential and risk involved when using this strategy is unlimited. An investor who enters a synthetic short stock strategy can gain large profits if the market crashes but can also incur big losses if it rallies. Moneyness Review for Puts and Calls Call Options: In-The-Money (ITM) = Strike price (less than) Market Price Out-of-The Money (OTM) = Strike price (more than) Market Price Put Options: In-The-Money (ITM) = Strike Price (more than) Market Price Out-of-The Money (OTM) = Strike Price (less than) Market Price Both Put and Call Options At-The-Money (ATM) Strike Price (equals) Market Price How to Implement a Synthetic Short Stock Strategy Disney stock is worth $40 (market price) in June. 1) Trader sells a call option: DISJul40($1.50) - 100 shares of DIS stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $1.50 2) Trader buys a put option: DISJul40($1.00) - 100 shares of DIS stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $1.00 3) The trader receives a $50 credit when entering the market [$150 (received from sale) - $100 (paid for put)] Result one: Disney stock rises (rallies) to $50 a) The put option expires worthless (OTM). b) The call option sold expires ITM. The investor who bought the trader's call option exercises his or her right to buy 100 shares at $40. c) The trader buys 100 Disney shares in the open market, paying $5000 d) He or she then sells them to the buyer, receiving $4000 e) The trader loses a total of $950 after subtracting the premium credit taken when entering the market. [$950 = $50 (credit to enter market) - $1000 (loss from call) ] Result two: Disney stock falls (crashes) to $30 a) The call option expires worthless (OTM). b) The put option expires ITM, and the trader buys 100 Disney shares in the open market, paying $3000 c) The trader exercises his or her right to sell the 100 shares at $40 to the investor who wrote the put option. d) The trader sells 100 Disney shares and receives $4000 from the writer. e) The Trader gains a total of $1050 after adding the premium credit taken when entering the market. [$1050= $1000 (profit from put) - $50 (credit to enter market)] Advantages and Disadvantages of Implementing a Synthetic Short Stock Strategy: Pluses: The upside to this type of strategy is that the investor will always make a profit in a bear market, which can lead to unlimited profit potential if prices crash. The trader also can enter the market without paying cash. He or she receives a premium credit, keeping it when the index call option expires worthless, and using the credit to offset losses, if the asset's value rises. Minuses: The downside in using a synthetic short stock strategy is that the method exposes the investor to unlimited risk. If the underlying asset's market value rallies, then he or she can lose large amounts of money, since an asset's price can theoretically rise as much as the demand permits.

Traders who implement a synthetic short call strategy are betting that the market price of an option's underlying asset will fall. The technique involves short selling owned assets and selling a put option for the amount of shares owned. The loss-risk in this strategy is unlimited, if the market price of the underlying asset rises. Traders who employ a synthetic short call strategy use assets as leverage to earn a fixed premium credit, received from the put buyer when entering the market. Moneyness Review for Puts Out-of-The Money (OTM) = Strike Price (less than) Market Price In-The-Money (ITM) = Strike Price (more than) Market Price At-The-Money (ATM) = Strike Price (equals) Market Price How to Carry out a Synthetic Short Call Strategy Disney stock is worth $50 (market price) in June. 1) Trader short sells 100 shares of Disney stock 2) Trader sells the put option: DISJul50($3) - 100 shares of Disney stock - Strike Price $50, at-the-money (ATM), expiring in 30 days - Premium Cost of $3 3) Trader receives a $300 credit when entering the market [$300 (received from put buyer)] Total cost to enter the market: -$300 Result one: Disney stock remains at $50 in July a) The put option sold expires worthless (OTM). b) The short sale realizes no gain. c) The trader's profits total $300 after keeping the credit earned when entering the market. Result two: Disney stock falls to $40 in July. a) The short sale realizes a $1000 gain, and the trader receives $1000. b) The put option sold expires ITM. c) The investor who bought the trader's put option exercises his or her right to sell 100 shares at $50. The trader pays $5000 to the buyer, and receives 100 Disney shares. d) The trader immediately sells the 100 shares in the open market and receives $4000. e) The trader makes a total profit of $300 after keeping the credit earned when entering the market. [$300 = $4000 (received for 100 shares) + $1000 (gain from short sale) + $300 (credit to enter market) - $5000 (paid for 100 shares)] Result three: Disney stock rises to $60 in July. a) The short sale realizes a $1000 loss, and the trader pays $1000. b) The put option sold expires worthless (OTM) c) The trader loses $700 after adding the credit earned when entering the market. [-$700 = $300 (credit to enter market) - $1000 (loss from short sale) ] Advantages and Disadvantages in Carrying out a Synthetic Short Call Strategy Pluses: The upside to this type of strategy is that the investor will gain limited profits if the put option expires at-the-money or expires at any price below it, independent of how low the market drops. The synthetic short call strategy also earns the trader a credit when entering the market, which can be used to offset losses if the underlying asset's market price rallies. Minuses: The downside in using a synthetic short call is that the method has an unlimited loss-risk potential. The short sale exposes the trader to high risk when the market rallies, since any asset's market price could theoretically rise as much as demand permits. The method also limits the trader's profit potential to only what he or she received when entering the market. The investor can not profit from the short sale if the market crashes because the put option would offset any gains from the sale.

Traders who implement a synthetic long put strategy are betting that the market price of an option's underlying asset will fall. The technique involves short selling owned assets and selling an ATM call option, hoping that it will expire OTM. Traders who employ this type of bear option strategy pay a premium to enter the market. However, gains from their call purchase will offset any potential loss from the short sale, thus, limiting the trader's losses. On the contrary, an investor's profit potential is infinite. If the market price crashes, traders who use this strategy can earn substantial gains. Moneyness Review for Calls Out-of-The Money (OTM) = Strike price (more than) Market Price In-The-Money (ITM) = Strike price (less than) Market Price At-The-Money (ATM) Strike price (equals) Market Price How to Carry out a Synthetic Long Put Disney stock is worth $40 (market price) in June. 1) Trader short sells 100 shares of Disney stock. 2) Trader buys the call option: DISJul40($2) - 100 shares of Disney stock - Strike Price $40, at-the-money (ATM), expiring in 30 days - Premium Cost of $2 3) Trader pays a total of $200 to enter the market. [$200 (paid to purchase one call option)] Total cost to enter the market: $200 Result one: Disney stock falls (crashes) to $30 in July. a) The call option purchased expires worthless (OTM). b) The short sale realizes a $1000 gain, and the trader receives $1000. c) The trader makes a total profit of $800 after subtracting the cost to enter the market. [$800 = $1000 (gain from short sale) - $300 (to enter the market)] Result two: Disney stock rises (rallies) to $50 in July. a) The short sale realizes a $1000 loss, and the trader pays $1000. b) The call option sold expires ITM. c) The trader exercises his or her right to buy 100 shares at $40 from the person who sold the call option. The trader pays $4000 to the buyer, and receives 100 Disney shares. d) The trader immediately sells the 100 shares in the open market and receives $5000. e) The trader losses $200 after adding the cost to enter the market. [-$200 = $5000 (received for 100 shares) - $4000 (paid for 100 shares) - $1000 (loss from short sale) - $200 (cost to enter market)] Result three: Disney stock falls (moderately) to $38 in July. a) The call option purchased expires worthless (OTM). b) The short sale realizes a $200 gain, and the trader receives $200. c) The trader makes a total profit of zero after adding the cost to enter the market. [$0 = $200 (gain from short sale) - $200 (to enter the market)]. Thus, $38 serves as this strategy's breakeven point, with any market value lower than $38 resulting in profits for the trader. Advantages and Disadvantages in Carrying Out A Synthetic Long Put Pluses: The upside to this type of strategy is that investors limit their losses when things go wrong. They also enter the market knowing where their break even point stands. Finally, the synthetic long put strategy gives investors the opportunity to realize large profits at a low and limited risk. Minuses: The only downside in carrying out this strategy happens when the market rallies and the call option expires ITM. However, investors would only lose what they paid in premiums to enter the market.

Traders who implement a protective call strategy are protecting their short sales from surprise market rallies. The protective call acts as an insurance policy from price swings on shares owed. The technique involves short selling assets and purchasing a call option for the amount of shares owned. The protective call limits the investor's loss potential to only the premiums paid when buying the call. Thus, the investor controls their loss, which is set by the terms of the call option. On the contrary, an investor's profit potential is infinite. If the market price crashes, traders who use this strategy can earn substantial gains. Moneyness Review for Calls Out-of-The Money (OTM) = Strike price (more than) Market Price In-The-Money (ITM) = Strike price (less than) Market Price At-The-Money (ATM) Strike price (equals) Market Price How to Carry Out A Protective Call Strategy Disney stock is worth $50 (market price) in June. 1) Trader short sells 100 shares of Disney stock. 2) Trader buys the call option: DISJul50($2) - 100 shares of Disney stock - Strike Price $50, at-the-money (ATM), expiring in 30 days - Premium Cost of $2 3) Trader pays $200 to enter the market and to protect the short sale. [$200 (paid for call)] Total cost to enter the market: $200 Result one: Disney stock rises (rallies) to $70 in July. a) The short sale realizes a $2000 loss, and the trader pays $2000. b) The call option expires ITM. c) The trader exercises his or her right to buy 100 shares at $50 from whoever sold the call option. The trader pays $5000 to the seller, and receives 100 Disney shares. d) The trader immediately sells the 100 shares in the open market and receives $7000. e) The trader loses $200 after adding the cost to enter the market. [$200 = $7000 (share sale) - $5000 (paid for shares) – $2000 (short sale loss) - $200 (cost to enter market)] Result two: Disney stock falls to $30 in July. a) The short sale realizes a $2000 gain, and the trader receives $2000. b) The call option purchased expires worthless (OTM). c) The trader makes a total profit of $1800 after adding the cost to enter the protective call. [$1800 = $2000 (received from short sale) - $200 (paid for protective call)] Result three: Disney stock drops (moderately) to $48 in July. a) The short sale realizes a $200 gain, and the trader receives $200. b) The call option purchased expires worthless (OTM). c) The trader makes a total profit of $0 after adding the cost to enter the protective call. [$0 = $200 (received from short sale) - $200 (paid for protective call)] **Note: In this example, Disney stock at $48 is the breakeven point in this protective call example. Any rally above $48 will result in a loss for the trader. However, the protective call caps the maximum loss at $200. Advantages and Disadvantages in Carrying Out a Protective Call Strategy Pluses: The upside to this type of strategy is that the investor can gain unlimited profits if the call option expires any price below its breakeven point. The protective call also helps investors control losses from sudden market rallies, as they predetermine their maximum loss when they enter the market. Minuses: The downside in using a protective call happens when the market rallies and the investor losses the premiums paid to purchase the call.

Traders who implement an in-the-money naked call strategy are betting that the market price of an option's underlying asset will fall. The technique involves selling an in-the-money call option, hoping that it will expire out-of-the money. Traders who employ this type of bear option strategy do not need cash to enter the market. However, the terms of their call sale will limit their profit potential. On the contrary, an investor's loss potential is infinite. If the market price rallies, traders who use this strategy will incur large monetary losses. Moneyness Review for Calls Out-of-The Money (OTM) = Strike price (more than) Market Price In-The-Money (ITM) = Strike price (less than) Market Price At-The-Money (ATM) Strike price (equals) Market Price How to Carry Out An In-The-Money Naked Call Strategy Disney stock is worth $48 (market price) in June. 1) Trader sells the call option: DISJul40($10) - 100 shares of Disney stock - Strike Price $40, in-the-money (ATM), expiring in 30 days - Premium Cost of $10 2) Trader receives a $1000 credit when entering the market [$1000 (received from call buyer)] Total cost to enter the market: -$1000 Result one: Disney stock rises (rallies) to $68 in July a) The call option sold expires ITM, and the investor who bought the trader's call option exercises his or her right to buy 100 shares at $40. b) The trader purchases 100 Disney shares in the open market to cover the short sale, paying $6800, and then sells the shares to the buyer, receiving $4000. c) The trader loses a total of $1800 after subtracting the premium credit taken when entering the market. [-$1800 = $1000 (credit to enter market) - $2800 (loss from call)] Result two: Disney stock falls (moderately) to $45 in July. a) The call option sold expires ITM, and the investor who bought the trader's call option exercises his or her right to buy 100 shares at $40. b) The trader purchases 100 Disney shares in the open market to cover the short sale, paying $4500, and then sells the shares to the buyer, receiving $4000. c) The trader's profit totals $500 after subtracting the loss from premium credit taken when entering the market. [$500 = $1000 (credit to enter market) - $500 (loss from call)] Result three: Disney stock falls (crashes) to $28 in July. a) The call option sold expires worthless (OTM). b) The trader's profits totals $1000 after keeping the credit earned when entering the market. Advantages and Disadvantages in Carrying Out An In-The-Money Naked Call Strategy Pluses: The upside to this type of strategy is that investors do not need cash to enter the market. They are betting that the asset's market value will crash and the call will expire OTM, allowing them to keep the credit earned when entering the market. Traders can also use the credit to gain a profit in moderate bull markets or to offset losses if the underlying asset's value rallies. Minuses: The downside in using an in-the-money naked call strategy is that it exposes traders to high-risk losses when the market rallies, since any asset's market price could theoretically rise as much as demand permits. The method also limits the trader's profit potential to only what he or she received when entering the market.

Traders who implement covered put strategies are betting that the market price of an option's underlying asset will fall. The technique involves short selling owned assets and selling a put option for the same amount of shares. The loss-risk in this strategy is unlimited, if the market price of the underlying asset rises. Traders who employ covered put strategies use their assets as leverage to earn a fixed premium credit, which is received from the put buyer when entering the market. Moneyness Review for Puts Out-of-The Money (OTM) = Strike Price (less than) Market Price In-The-Money (ITM) = Strike Price (more than) Market Price At-The-Money (ATM) = Strike Price (equals) Market Price How to Carry out Covered Puts Strategies Disney stock is worth $45 (market price) in June. 1) Trader short sells 100 shares of Disney stock 2) Trader sells the put option: DISJul45($2) - 100 shares of Disney stock - Strike Price $45, at-the-money (ATM), expiring in 30 days - Premium Cost of $2 3) Trader receives a $200 credit when entering the market [$200 (received from put buyer)] Total cost to enter the market: -$200 Result one: Disney stock remains at $45 in July a) The put option sold expires worthless (OTM) b) The short sale realizes no gain. c) Trader profits total $200 after keeping the credit earned when entering the market. Result two: Disney stock falls to $40 in July. a) The short sale realizes a $500 gain, and the trader receives $500. b) The put option sold expires ITM. c) The investor who bought the trader's put option exercises his or her right to sell 100 shares at $45. The trader pays $4500 to the buyer, and receives 100 Disney shares. d) The trader immediately sells the 100 shares in the open market and receives $4000. e) The trader makes a total profit of $200 after keeping the credit earned when entering the market. [$200 = $4000 (received for 100 shares) + $500 (gain from short sale) + $200 (credit to enter market) - $4500 (paid for 100 shares)] Result three: Disney stock rises to $55 in July. a) The short sale realizes a $1000 loss, and the trader pays $1000. b) The put option sold expires worthless (OTM) c) The trader loses $800 after adding the credit earned when entering the market. [-$800 = $200 (credit to enter market) - $1000 (loss from short sale) ] Advantages and Disadvantages in Carrying Out Covered Put Strategies Pluses: The upside to this type of strategy is that the investor will gain limited profits if the put option expires at-the-money or expires at any price below it. Profits remain the same, independent of how low the market drops. Covered put strategies also earn traders a credit when entering the market, which can be used to offset losses if the underlying asset's market price rallies. Minuses: The downside in using covered put strategies is that the method has an unlimited loss-risk potential. The short sale exposes traders to high risk when the market rallies, since any asset's market price could theoretically rise as much as demand permits. The method also limits the trader's profit potential to only what he or she received when entering the market. Investors can not profit from their short sale if the market crashes because the put option would offset any gains.

Options are a high-risk investment, but they are also highly profitable. Traders enter the option market for many reasons. One reason is because the amount of capital required to enter the market is lower than regular stock. The fact that most options move faster (volume) and produce higher returns is another reason traders dabble in the option market. Many brokerage houses limit the amount of cash (margin) new traders can use to invest because of the market's high potential for loss. As option traders become experts, these limitations go away, and the trader is free to invest as much as their account allows. Once a new trader gets familiar with how the option market works, they can become an expert in no time at all. Stock vs. Option Regular or preferred stock is an asset. In other words, stock is equity, and it gives the holder ownership in the company where it's drawn from. It trades easy in the exchange because, like money, investors consider it a liquid asset. An option is a derivative of stock. This means that its value completely depends on the value of the equity associated with it. Option Buyers: Option buyers own a contract that says they have the right to buy or sell an asset by a certain date (expiration date). Option buyers are not obligated to buy or sell the asset, and if they choose not to, they let their option expire as it becomes worthless. Option Sellers: Option sellers own a contract that obligates them to buy or sell an asset by a certain date (expiration date), if the buyer excercises the option. Most option sellers hope the buyer's contract expires, so they can collect premiums. Online Brokers Most investors trade options using an online broker system that connects directly to the brokerage house holding trader's investment account. Traders send orders through their broker, which go directly to an exchange. Their brokerage house, which has a seat on the exchange floor, receives the investor's order and sends the trader's request to auction after deducting or adding funds to their investment account. All this takes place in real-time, which occurs in a matter of seconds. Expiration Every option expires. Traders call an option's expiration date, the strike date, because it stands as a marker where all options must be either be bought or sold. On or before the strike date, the trader can either choose to exercise the option and buy the underlying asset, or they can let the option expire, where its value then becomes worthless. Strike Price, Exercise & Assignment An option's strike price is the value an investor will pay to exercise their right to buy or sell the option. If a buyer chooses to exercise the option, the brokerage house assigns the seller's assets to the buyer's account. Margin Requirements Margin is the total amount in which an investor can use to make a trade. Most traders make a deposit at a brokerage house, which serves as collateral for buying and selling options. Normally, the trader can only buy or sell options up to the balance available in their account (margin). Sometimes, brokerage firms extend credit to the trader, which adds on to their margin's limit. However, if at any time a trader buys an option on credit (borrowed margin), makes a bad choice, and their option starts to lose value, the brokerage house has the right to immediately sell the option to cover the margin (margin call). Order Entry Home broker systems basically have two types of transactions, buy and sell. Investors can fine-tune their orders by adding details to the order, including limit, stop or market, which directs their broker on how to specifically auction it. Types of orders In each of the two types of order entries, there are two types of orders that a trader can place. Call Orders Buying a call option - Trader buys a call option thinking its price will go up (long-buying). Buying the underlying asset is not an obligation. Selling a call option - Trader sells (writes) a call option thinking its price will go down (short-selling). Trader must sell the underlying asset, if a buyer exercises the option. Put Orders Buying a put option - Trader buys a call option thinking its price will go down. Selling the underlying asset is not an obligation. Selling a put option - Trader buys a call option thinking its price will go up. Trader must buy the underlying asset, if a buyer exercises the option. Moneyness Moneyness is the real value of an option. An option starts to lose value the minute it enters the market. The closer it gets to its expiration date, the less it's worth. Investors call this occurrence time decay. Intrinsic value is simply the difference between an option's strike price and the underlying asset's market price. Option traders calculate moneyness by adding an option's intrinsic value to its time decay value. NEXT: [thread=11548]Call Option[/thread]

Traders who implement the collar strategy are betting that the market price will go up for the assets owned in their portfolio. The technique involves buying put options and writing (selling) the same amount of call options for the identical underlying asset. Traders use this method to protect their long position from a bear market. The potential profit and the potential loss are limited when entering this type of position. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important when considering the risks involved in implementing the collar strategy. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options: ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement The Collar Strategy (OTM) XYZ is worth $48 (market price) 1) Trader buys 100 shares of XYZ preferred stock and pays $4800. 2) Trader writes (sells) a call option: XYZJul50($2) - 100 shares of XYZ stock - Strike Price $50 (OTM), expiring in 30 days - Premium Cost of $2 3) Trader buys a put option: XYZJul45($1) - 100 shares of XYZ stock - Strike Price $45 (OTM), expiring in 30 days - Premium Cost of $1 4) Trader receives a total credit of $100 in premiums [($200 (received from the call) - $100 (paid for the put)] Total Investment cost: $4700 [$4800 (paid) - $100 (premium credit)] Result one: XYZ hits $53 a) The put option expires worthless (OTM). b) The call option is ITM. The call buyer exercises his or her right to buy the writer's 100 shares at $50, and pays $5000 to the trader. c) The trader makes a total profit of $300 after subtracting the total investment cost from the profit made on the call. [$300 = $5000 (profit from call) - $4700 (cost of investment)] Result two: XYZ hits $43 a) The call option expires worthless (OTM). b) The put option is ITM. The trader exercises his or her right to sell 100 shares at $45 and receives $4500 his or her shares. c) The trader loses a total of $200 after adding after subtracting the total investment cost from the sale of the shares. [-$200 = $4500 (received from put) - $4700 (cost of investment)] Result three: XYZ hits $48 a) The put option expires worthless (OTM). b) The call option expires worthless (ATM). c) The trader makes a total profit of $100 after keeping the premium credit from the call and the put options. Advantage and Disadvantage of Implementing The Collar Strategy: Pluses: The upside to this type of strategy is that the investor will always make a limited profit in a bull market. Another advantage in using the collar strategy is that the trader also knows exactly how much he or she would lose if the market declines, since their loss risk is also limited by the terms of the put option. Minuses: The downside in using covered combination strategy is that the method limits an investor's profits. If the underlying asset's market value explodes, the trader would only receive what he or she gains from the call option.

Traders who carry out a synthetic short put strategy are betting that the market price will go up for the shares owned in their portfolio. The technique involves writing (selling) call options for the owned underlying asset. The reason investors refer to this as a put strategy instead of a call is because the profit potential functions the same as it would in a short put approach. When implementing a synthetic short put, traders gain limited premiums as the market rises, but they expose themselves to unlimited loss risk when the market value of the option's underlying asset falls. Definition of ATM, ITM and OTM for Synthetic Short Puts There are three ways to define the relationship between a call option's strike price and the market price of its underlying asset. Understanding the differences between the terms is important because the risks involved in buying puts depend on these terms at the time of the purchase and when assigning assets. ATM - At The Money: The underlying asset's market price equals the option's strike price. Example: - Put Option XYZJan50 (strike price $50) - XYZ is trading at $50 ITM - In The Money: The underlying asset's market price is more than option's strike price. Example: - Put Option XYZJan50 (strike price $50) - XYZ is trading at $60 OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Example: - Put XYZJan50 (strike price $50) - XYZ is trading at $40 How to Implement a Synthetic Short Put Strategy (ATM) XYZ is trading at $50 (market price) 1) Trader buys 100 XYZ shares for $5000 (100 x $50 share cost)). 2) Trader writes (sells) a call option: XYZJan50($3) - 100 shares of XYZ stock - Strike Price $50 (ATM), expiring in 30 days - Premium Cost of $3 3) Trader receives $300 from the buyer [100 x $3 (premium cost)]. Total Investment cost: $4700 ($5000-$300) Result one: XYZ hits $55 (ITM). The call buyer exercises the option to buy 100 shares at $55. The call seller sells his or her 100 shares and receives at $5500 for a total profit of $800 ($5500 received from buyer - $4700 total investment cost). Result two: XYZ hits $43 (OTM). The call buyer lets the contract expire. In this example, the option seller would keep the 100 shares and the $300 in premiums collected, but would suffer a $700 loss on paper ($4300 asset's worth -$5000 paid). The total loss reduces to $400 when adding the premiums received from the call. Result three: XYZ hits $50 (ATM). The call buyer lets the contract expire. In this example, the option seller would keep 100 shares and the premiums collected for a total profit of $300 ($300 received in premiums). Advantage and Disadvantage of a Covered Call Strategy: Pluses: The upside to this type of strategy is that traders get to earn a limited premium on top of any gain on paper from their owned assets. Another advantage to the synthetic short put strategy is that premiums earned can reduce any loss incurred from a decline in the underlying asset's market price, down to the investment's break even point. Minuses: The downside to implementing a synthetic short put strategy is that a trader's profits are limited to only the gain on paper plus the premiums received from the call buyer. The investor can not receive any profits from gains the underlying asset's market price because he or she would have sold the asset upon assignment. Finally, if the underlying asset's market value falls, the trader's risk becomes unlimited, as the asset's price could decline to a zero value.

Traders who carry out a stock repair strategy try to recover losses on their long positions sustained from an earlier period. The technique involves implementing a call ratio spread, usually 2:1, consisting of buying one call option and selling two. A rise in the market repairs a trader's losses. The call ratio spread can repair losses in a bear market, up to the ratio's breakeven point. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important when considering the risks involved in implementing a stock repair strategy. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options: ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options: ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Stock Repair Strategy Precondition: **XYZ is worth $50 (market price) in May **Trader buys 100 XYZ shares for $5000 (100 x $50 share cost)) **XYZ declines to $40 (market price) in June **Trader loses $1000 on paper [-$1000 = $4000 (current market value) - $5000 (investment cost)] Stock Repair (2:1 Ratio): XYZ is worth $40 (market price) 1) Trader buys one call option: XYZJul40($2) - 100 shares of XYZ stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $2 2) Trader writes (sells) two calls options: XYZJul45($1) - 100 shares of XYZ stock - Strike Price $45 (OTM), expiring in 30 days - Premium Cost of $1 3) Trader pays nothing to repair the stock because the premiums offset each other [$200 (paid for call) - $200 (received from put)]. Result one: XYZ hits $45 a) The two call options sold expire worthless (OTM). b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller and sells the shares in the open market for $4500. c) The trader also sells his or her long position for $4500. d) The trader makes a total profit of $1000 [$1000 = $500 (profit from call) + $500 (profit from long)]. The $1000 repairs the trader's loss from a month earlier. Result two: XYZ hits $60 a) The two call options sold are ITM. The call buyer exercises his or her right to buy 200 shares at $45. b) The call option purchased is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the seller. c) The trader delivers 200 shares (100 from the long position and 100 from call purchase) to the call buyer, and he or she receives $9000. d) The trader makes a total profit of $5000 from the current month's trading [$9000 (received from call sale) - $4000 (paid for call purchase)]. e) The trader actually breaks even because the $5000 profit offsets the $5000 that trader paid to enter the market a month ago before the loss. [$0= $5000 (profit from current month) - $5000 (cost of investment)]. Result three: XYZ hits $30 a) The two call options sold expire worthless (OTM). b) The call option purchased expires worthless (OTM). c) The trader keeps his or her long position and loses another $1000 in paper value [-$2000 = $3000 (current market value) - $5000 (investment cost)]. Advantage and Disadvantage of Implementing a Stock Repair Strategy: Pluses: The upside to this type of strategy is that the investor pays nothing to repair the stock, and he or she will always recover losses in a bull market. Another advantage in using a stock repair strategy is that even if the market continues to fall, traders can still recover their losses up to the call ratio's break even point. Minuses: The downside in using a stock repair strategy is that if the market falls past the call ratio's break even point, the long position will continue to lose value.

An uncovered put write, or a "naked put" as it is frequently called by investors, is an investing strategy which is fundamentally a bet on a stock either staying near its current price or going up. The put in this case is called uncovered because the put writer does not own the underlying stock. Instead, the option trader simply writes put contracts at a strike price and collects the premium. If the stock price stays at or above the strike price to expiration, then the trader collects the premium as profit. However, if the price falls below the strike price, then losses are unlimited (except for the premium) until the stock price reaches zero. To see how this works (see diagram) suppose stock XYZ is trading at $45 and the trader writes 1 uncovered put contract at a strike price of $45 for a premium of $2. This would cost $200 for a contract (1 contract=100 shares). If the stock price goes up or stays at $45 all the way to the option expiration date, the trader keeps the premium ($200) as the maximum profit. However, if the price falls below the strike price, then losses depend on the expiration price. For example, if the price at expiration is $40 then the loss would be $5 per share or $500 minus the premium price of $200 for a total loss of $300. Maximum loss would be if the stock price went to $0 which would be $45 per share or $4500 (minus the premium collected). When to use uncovered puts The best time to use uncovered puts is in periods of low volatility for a stock. If the trader feels there will be little price change in a stock over time, then uncovered puts are a valid strategy. Some traders use these instruments as a major source of income, collecting premiums from expired contracts month-after-month. However, uncovered puts do carry with them a high amount of downside risk if the price of a stock goes down rapidly. Therefore, it is best not to write uncovered puts before an earnings report, expected news release, or any other known factor that could rapidly move the stock price. There is also the risk that if the put is held to expiration, the put will be executed and the put writer will have to take delivery of the stock. The stock could then continue its decline and increase losses. Because of factors such as these, many brokers will not allow traders to write uncovered puts without a substantial amount of capital to serve as security in case of loss. Types of stocks that work well with uncovered puts The type of stocks that work well with the uncovered put strategy tend to be large, blue chip type stocks that have low volatility and a stable, long-term price trend. It is also wise to choose stocks such as these that are: (1) on a relative uptrend in terms of revenues and earnings or (2) have just been through a strong selloff as a way to hedge against any unforeseen downside price movement.

Traders who carry out a synthetic long (split strikes) stock strategy are betting that the market price for an option's underlying asset will go up. The technique involves buying call options and writing (selling) the same amount of put options for the identical underlying asset. Traders who use this method enter the market receiving a credit or paying nothing. The synthetic long (split strikes) is a less aggressive strategy than its cousin, the synthetic long stock, giving the trader more of a cushion against minor market downturns. The potential profit and the potential loss are unlimited when entering this type of synthetic position. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important when considering the risks involved in implementing a synthetic long (split strikes) stock strategy. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Synthetic Long Stock Strategy (Split Strikes) (OTM) XYZ is worth $40 (market price) 1) Trader writes (sells) a put option: XYZJun35($1) - 100 shares of XYZ stock - Strike Price $35 (OTM), expiring in 30 days - Premium Cost of $1 2) Trader buys a call option: XYZJun45($.50) - 100 shares of XYZ stock - Strike Price $45 (OTM), expiring in 30 days - Premium Cost of $.50 3) Trader receives a total credit of $50 in premiums to enter the market [$100 (received from put) - $50 (paid for call)]. Result one: XYZ hits $45 (Moderate Bull Market) a) The put option expires worthless (OTM). b) The call option expires worthless (ATM). c) The trader makes a total profit of $50 after keeping the premium credit from the call and the put. Result two: XYZ hits $60 (Explosive Bull Market) a) The put option expires worthless (OTM). b) The call option is ITM. The trader exercises his or her right to buy 100 shares at $45, pays $4500 to the seller and sells the 100 shares in the open market for $6000. c) The trader makes a total profit of $1550 after adding the premium credit received when entering the market. [$1550 = $1500 (profit from call) + $50 (credit to enter market)] Result three: XYZ hits $20 (Market Crashes) a) The call option expires worthless (OTM). b) The put option is ITM. The put buyer exercises his or her right to sell 100 shares at $35. The trader pays $3500 to the put buyer and sells the 100 shares received from the buyer in the open market for $2000. c) The trader loses a total of $1450 after subtracting the premium credit received when entering the market. [$1450 = $1500 (loss from put) - $50 (credit to enter market] Advantage and Disadvantage of Implementing a Synthetic Long Stock Strategy (Split Strikes): Pluses: The upside to this type of strategy is that the investor can make unlimited profits in a bull market, since the potential growth of any underlying asset is infinite. Another advantage to this technique is that the investor can enter the market receiving a credit that she or she can use to offset minor market downswings. Minuses: The downside in using synthetic long (split strikes) strategy is when the underlying asset's market value falls dramatically. When this happens, the trader's loss risk becomes unlimited, as an asset's market price can decline to a zero value.

Traders who implement a synthetic long stock strategy are betting that the market price for an option's underlying asset will go up. The technique involves buying call options and writing (selling) an equal amount of put options for the same underlying asset. Traders who use this method enter the market at low-to-zero cost. Both the potential profit and the potential loss are unlimited when entering this type of synthetic position. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important when considering the risks involved when implementing a synthetic long stock strategy. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Synthetic Long Stock Strategy (ATM) XYZ is worth $40 (market price) 1) Trader writes (sells) a put option: XYZJan40($1) - 100 shares of XYZ stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $1 2) Trader buys a call option: XYZJan40($1.50) - 100 shares of XYZ stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $1.50 3) Trader pays a total of $50 in premiums to enter the market [$150 (paid for call) - $100 (received from put)] Result one: XYZ hits $50 a) The put option expires worthless (OTM). b) The call option is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the writer, and immediately sells the shares in the open market for $5000. c) The trader makes a total profit of $950 after subtracting the premiums paid to enter the market. [$950 = $1000 (profit from call) - $50 (cost to enter market)] Result two: XYZ hits $30 a) The call option expires worthless (OTM). b) The put option is ITM. The put buyer exercises his or her right to sell 100 shares at $40. The trader pays $4000 to the put buyer and sells the 100 shares received from the buyer in the open market for $3000. c) The trader loses a total of $1050 after adding the cost to enter the market. [$1050 = $1000 (loss from put) + $50 (cost to enter market)] Advantage and Disadvantage of Implementing a Synthetic Long Stock: Pluses: The upside to this type of strategy is that the investor can make unlimited profits in a bull market, since the potential growth of any underlying asset is infinite. Another advantage to this technique is that the investor can enter the market at a very low cost. Minuses: The downside in using a synthetic long stock strategy is when the underlying asset's market value falls. When this happens, the trader's loss risk becomes unlimited, as an asset's market price can decline to a zero value.

A synthetic long call is a synthetic trade meaning that it is a trade involving an underlying security compounded by derivatives (in this case options). The investor in this case has decided that the stock price will go up (hence the term "call") and buys the stock while simultaneously buying near-the-money puts. This type of position insures the stockholder a maximum loss of the put's strike price and at the same time unlimited potential profits. For example (see diagram) if the shareholder has 100 shares of stock XYZ with a share price of $52, then a contract (1 contract=100 shares) can be purchased to limit losses at the strike price of the option. Suppose the option strike price is $50, then the maximum loss per share is $2 plus the premium paid (the cost of purchasing a contract). Suppose the premium for a contract is $2 (1 contract =100 shares=$200), then the maximum loss in the trade is $400. On the other hand, the profit potential is unlimited if the share price goes up and the only loss is that of the premium paid of $200. If the stock reaches $54, then the shareholder has broken even in the trade and realizes only profit as the stock goes up. When are synthetic long calls a valid strategy? Synthetic long calls are a bullish position and are valid strategy for playing riskier, higher volatility stocks while at the same time reducing the amount of inherent risk in incurring a steep loss. Investors who desire to play such a stock for the chance of extreme profits (such as in a much-hyped tech stock) often use this strategy. In this case, the puts purchased provide a level of insurance in case the trade goes wrong and the stock gets crushed. Investors who use this strategy have to pay close attention to the amount of implied volatility (IV) in premium prices since the maximum loss incurred can be much more substantial with higher premium prices. The synthetic long call is also a valid strategy when more versatility is needed by the investor in assessing the stock's performance. For example, the investor can sell the put at any time, sell the stock at any time, or execute delivery at the strike price. This allows a change in overall strategy for the trade all the way until the option's expiration. Types of stocks in which to consider long call strategy Stocks that respond well to this strategy are oftentimes small to mid-cap sized stocks with moderate to high amounts of volatility. Stocks with higher price swings that have just been through a steep selloff or where good news is expected are good candidates for a long call. Volatile ETFs and index funds as well are candidates for this strategy. One of the keys to putting on the lowest risk trade with any of these stocks is to pay attention to implied volatility in premium prices and go for the lowest possible put option price in order to avoid sharp drops in implied volatility. This would minimize any loss should the stock trade sideways.

Traders who implement a covered straddle strategy are betting that the market price will go up for the assets owned in their portfolio. The technique involves writing (selling) the same amount call and put options for owned shares. Traders gain limited premiums when the market rises, but they expose themselves to unlimited loss risk when the market value of the option's underlying asset falls. The covered straddle strategy is similar to placing two covered calls. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important because of the risks involved in when the market declines and when assigning assets. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options: ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options: ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Covered Straddle Strategy (ATM) XYZ is worth $54 (market price) 1) Trader buys 100 shares of XYZ preferred stock and pays $5400. 2) Trader writes (sells) a put option: XYZJan55($3) - 100 shares of XYZ stock - Strike Price $55 (ATM), expiring in 30 days - Premium Cost of $3 3) Trader writes (sells) a call option: XYZJan55($4) - 100 shares of XYZ stock - Strike Price $55 (ATM), expiring in 30 days - Premium Cost of $4 4) Trader receives $700 in premiums ($300 from put + $400 from call) Total Investment cost: $4700 [$5400 (paid) - $700 (premiums collected)] Result one: XYZ hits $57 a) The put option expires worthless (OTM), and the trader keeps the $300 in premiums. b) The call option is ITM. The call buyer exercises his or her right to buy the seller's 100 shares at $55, paying $5500 to the seller. c) The trader makes $800 after subtracting the amount received from the call option from the total cost of investment. [$800 = $5500 (call sale) - $4700 (cost of investment)] Result two: XYZ hits $45 a) The call option expires worthless (OTM), and the trader keeps the $400 in premiums. b) The put option is ITM. The put buyer exercises his or her right to sell 100 shares at $55. The writer sells his 100 shares in the open market receiving $4500 and adds $1000 out of his or her pocket to pay $5500 to the put buyer. c) The 100 shares received from the buyer suffer a $200 paper loss. [$4500 (current market value) - $4700 (cost of investment)] d) The trader loses a total of $1200 after adding the amount paid out-of-pocket to the paper loss on shares owned. [$1200 = $1000 (paid out-of-pocket) - $200 (paper loss)] Advantage and Disadvantage of Implementing a Covered Straddle Strategy: Pluses: The upside to this type of strategy is that the investor will always make a limited profit in a bull market. Another advantage in using a covered straddle strategy is that the premiums collected give the trader a discount on the total cost of the investment. Minuses: The downside in using a covered straddle strategy is that the method limits an investor's profits. Also, if the underlying asset's market value falls, the trader's risk becomes unlimited, as an asset's price can decline to a zero value.

Traders who implement a covered combination strategy are betting that the market price will go up for the assets owned in their portfolio. The technique involves writing (selling) the same number of call and put options for shares owned of an underlying asset. Traders gain limited premiums when the market rises, but they expose themselves to unlimited loss risk when the market value of the option's underlying asset falls. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important because of the risks involved in when the market declines and when assigning assets. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options: ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Covered Combination Strategy (OTM)XYZ is worth $52 (market price) 1) Trader buys 100 shares of XYZ preferred stock and pays $5200. 2) Trader writes (sells) a put option: XYZJan50($1) - 100 shares of XYZ stock - Strike Price $50 (OTM), expiring in 30 days - Premium Cost of $1 3) Trader writes (sells) a call option: XYZJan55($1) - 100 shares of XYZ stock - Strike Price $55 (OTM), expiring in 30 days - Premium Cost of $1 4) Trader receives $200 in premiums ($100 from the put + $100 from the call) Total Investment cost: $5000 [$5200 (paid) - $200 (premiums collected)] Result one: XYZ hits $57 a) The put option expires worthless (OTM). b) The call option is ITM. The call buyer exercises his or her right to buy the writer's 100 shares at $55, and pays $5500 to the trader. c) The trader makes a total profit of $500 after subtracting the amount received from the call from the total cost of the investment. [$500 = $5500 (received from call) - $5000 (cost to enter market)] Result two: XYZ hits $45 a) The call option expires worthless (OTM). b) The put option is ITM. The put buyer exercises his or her right to sell 100 shares at $50. The writer sells his or her 100 shares in the open market receiving $4500 and adds $500 out of his or her pocket to pay $5000 to the put buyer. c) The 100 shares received from the buyer suffer a $500 paper loss. [$4500 (current market value) - $5000 (cost of investment)] d) The trader loses a total of $1000 after adding the amount paid out-of-pocket to the paper loss on shares owned. [$500 = $1000 (paid out-of-pocket) - $500 (paper loss)] Advantage and Disadvantage of Implementing a Covered Combination Strategy: Pluses: The upside to this type of strategy is that the investor will always make a limited profit in a bull market. Another advantage in using a covered combination strategy is that the premiums collected give the trader a discount on the total cost of the investment. Minuses: The downside in using covered combination strategy is that the method limits an investor's profits. Also, if the underlying asset's market value falls, the trader's risk becomes unlimited, as an asset's price can decline to a zero value.

Traders who sell index puts are betting that the market price of the index's underlying value will go up. The strategy involves selling a put that's associated with a stock market index. The index plays the same role as an underlying asset does in normal options trading. Investors settle their exercised index options in cash, so there are no assignments of assets. When traders sell index puts, they forecast that the option will expire OTM and worthless. The most a trader can gain is limited to the amount that he or she receives in premiums. At the same time, there is no limit to how much an investor can lose, since the potential decline of any stock index is infinite. Definition of ATM, ITM and OTM for Puts There are three ways to define the relationship between an option's strike price and the market price of the underlying index. Understanding the differences between the terms is important because the risks involved in selling index puts depend on these terms at the time of the sale and when settling for cash. ATM - At The Money: The underlying index's market price equals the option's strike price. Example: - Put Option DJX400 (strike price $400) - Index DJX is trading at $400 ITM - In The Money: The underlying index's market price is less than option's strike price. Example: - Put Option DJX400 (strike price $400) - Index DJX is trading at $380 OTM - Out of The Money: The underlying index's market price is more than option's strike price. Example: - Put Option DJX400 (strike price $400) - Index DJX is trading at $420 How to Sell Index Puts (ATM) The DJX is worth $400 (market price) 1) Trader writes (sells) an index put option: DJX400($4) - One Option with a contract multiplier of $100 - Strike Price $400 (ATM) - Premium Cost of $4 2) Trader receives $400 in premiums (100 x $4 (premium cost)). Result one: DJX hits $380 (ITM). The put buyer exercises his or her right to sell 100 shares at $40. The difference between the option's strike price and the DJX is $20 (Option $400 - DJX $380). Since there is no assignment of assets, the trader settles in cash for $2000 (100 x $20). The investor's total loss is reduced to $1600 after adding premiums received. Result two: DJX hits $420 (OTM). The put buyer lets the option expire, does not exercise his or her right to sell and loses the amount of premiums paid. In this example, the writer would profit $400 (premiums paid). Advantage and Disadvantage of Selling Index Puts: Pluses: The upside to selling index puts is that the investor can enter the market without paying cash. They in fact are issuing an IOU, hoping that the obligation will expire worthless. Minuses: The downside is that a trader's profits are limited to only the premiums received from the put buyer. Also, the potential loss risk in selling puts is unlimited, as an index can decline up to a zero value.

Traders who enter married put strategies want to own an option's underlying asset, but are unsure if the asset's bullish trend will continue in the short-term. The strategy involves buying a put option ATM and buying the same number of regular shares of the underlying asset. When traders buy the put option, they are essentially purchasing insurance. The most a trader can lose is limited to the amount that he pays in premiums and the difference in the share price on paper. At the same time, there is no limit to how much an investor can gain, since the potential rise of any underlying asset is infinite. Definition of ATM, ITM and OTM for Married Puts There are three ways to define the relationship between a put option's strike price and the market price of its underlying asset. Understanding the differences between the terms is important because the risks involved in buying puts depend on these terms at the time of the purchase and when assigning assets. ATM - At The Money: The underlying asset's market price equals the option's strike price. Example: - Put Option XYZJan52 (strike price $52) - XYZ is trading at $52 ITM - In The Money: The underlying asset's market price is less than option's strike price. Example: - Put XYZJan52 (strike price $52) - XYZ is trading at $30 OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Example: - Put Option XYZJan52 (strike price $52) - XYZ is trading at $70 How to Enter a Married Put Strategy (ATM) XYZ is worth $52 (market price) 1) Trader buys 100 shares of XYZ preferred stock and pays $5200. 2) Trader buys the put option: XYZJan50($2) - 100 shares of XYZ stock - Strike Price $50 (ATM), expiring in 30 days - Premium Cost of $2 3) Trader pays $200 in premiums (100 x $2 (premium cost)). Result one ITM: XYZ hits $30 (ITM) Any drop in price below $50 puts the option ITM. If this happens, the trader will exercise the right to sell his or her 100 shares for $50 and will receive $5000 from the put seller. The trader's total loss will equal the premiums paid ($200) plus the difference between the asset's purchase price and its selling price (Paid $5200 - Received $5000 = $200). In this case, the total loss is $400. Result two OTM: XYZ hits $70 (OTM) Any rise in price above $50 puts the option OTM. If this happens, the trader will not exercise the right to sell his or her 100 shares. His or her underlying asset will have a paper value of $1800 (100 (shares) x $70 (market price). The $200 in premiums paid reduces the trader's profit to $1600. Result three ATM: XYZ hits $52 (ATM) If XYZ remains at $52 when the put option expires, the trader will not exercise the right to sell his or her 100 shares, but loses the $200 in premiums paid (insurance). Advantage and Disadvantage of Implementing a Married Put Strategy: Pluses: The upside to this type of strategy is that there are no limits to the amount of profit an investor can make. If the underlying asset's market value takes off, the investor's shares will grow on paper. Another advantage in the married put strategy is that the cost of insurance (buying a put) is very low. As a result, a trader can go long and pay only a small fixed premium if things go wrong. Minuses: The downside in implementing a married put strategy is that the investor loses when the value of the option fall ITM. Although, the most an investor can lose is limited.