A combination is an option trading strategy that involves the purchase and/or sale of both call and put options on the same underlying asset.
The straddle is an unlimited profit, limited risk option trading strategy that is employed when the options trader believes that the price of the underlying asset will make a strong move in either direction in the near future. It can be constructed by buying an equal number of at-the-money call and put options with the same expiration date.
Like the straddle, the strangle is also a strategy that has limited risk and unlimited profit potential. The difference between the two strategies is that out-of-the-money options are purchased to construct the strangle, lowering the cost to establish the position but at the same time, a much larger move in the price of the underlying is required for the strategy to be profitable.
The strip is a modified, more bearish version of the common straddle. Construction is similar to the straddle except that the ratio of puts to calls purchased is 2 to 1.
The strap is a more bullish variant of the straddle. Twice the number of call options are purchased to modify the straddle into a strap.
Combinations can be used to create options positions that have the same payoff pattern as the underlying. These positions are known as synthetic underlying positions. Using equity options as an example, a synthetic long stock position can be created by buying at-the-money call and selling an equal number of at-the-money put options.
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Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]
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Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]
In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]
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