29 Option Spread Strategies You Need to Know (Part 3)

⇐ Part 2 (#1 to #3)

This list of option spread strategies continues from an ongoing series.

This article features my option spread strategies, 4-8. It builds upon my previous article that identified option spread strategies, 1-3.

The strategies are:

 4) Iron Butterfly

The iron butterfly is a strategy for a low-movement underlying security. The price of the security is expected to remain steady up to the expiration date.

I buy one out-of-the-money put. I also sell one at-the-money-put, sell one at-the-money call and buy one out-of-the-money call.

The objective is for all options to expire worthless. In that case, I pocket the credit for selling the at-the-money options. Because of the option setup, I received a credit to enter this trade. With this strategy, my maximum profit is only the premium for the two at-the-money options. I risk losing money with the iron butterfly only if the underlying security moves either at or below the strike price of the put or the call that I bought.

5) Iron Condor

Like the basic condor, an iron condor is a limited risk, neutral approach strategy. With this strategy, you have a good chance of a small profit when the underlying security’s price does not move.

I sell one out-of-the-money put. I also sell one out-of-the-money call, buy one out-of-the-money put at a lower strike price and buy one out-of-the-money call at a higher strike price.

A nice aspect of the condor spread strategy is that I get paid in advance. I get the credit for selling the out-of-the-money put and the out-of-the-money call. The up-front credit is the most I can earn with this strategy. My loss risk is greater than my maximum profit potential. This is a disadvantage of the iron condor.

I lose money if the stock price falls below the put, if the stock price goes above the call or if the stock price matches either the put or the call. In any of those cases, my maximum loss will be the difference between the strike price of the calls or puts minus the credit received when I entered the trade.

In my experience, there are not many good reasons to use the iron condor.

6. Long Put Butterfly

The long put butterfly is another low-volatility or low-movement trade. Therefore, I will use this strategy when I think that the underlying security is not going to move much by expiration date.

I buy one out-of-the-money put. I also sell two at-the-money puts and buy one in-the-money put.

I earn money when the price of the underlying security does not go anywhere. In that case, the strike price of the highest put expires in the money. That is the one put I bought that was in the money.

My potential loss for the long put butterfly is limited to the initial price to enter the trade plus commissions. With this strategy, you take your loss up-front. You are looking for any potential gains in the future.

Many other trades, commonly called credit spreads, yield profit up-front, with any potential losses occurring in the future. I see the up-front credit as a better way to approach most trades.

7) Long Straddle

I already covered a long straddle — or a straddle in general — in a previous article. This strategy is one of my favorite option trading strategies. A long straddle provides unlimited profit potential and very limited risk. I use a straddle or, specifically, a long straddle whenever I trade in a market with a lot of volatility.

The long straddle is quite simple. I buy one at-the-money call and buy one at-the-money put.

I am expecting that the underlying security is going to go significantly

outside of the at-the-money strike price one way or the other. This means that either the put or the call will expire worthless. However, the other side will have unlimited profit potential.

8) Long Strangle

This is sometimes known as simply a strangle. The long strangle is another neutral trading strategy. As such, the long strangle allows us to trade when we do not have a good idea about the future market direction.

I happen to enjoy technical analysis. Generally, I come down on either a bearish or bullish side. Thus, I use mostly directional trading strategies. However, you might choose neutral trading strategies until you get a firm grasp on the technical read of the market.

The long strangle is another simple strategy. I buy one out-of-the-money call and buy one out-of-the-money put.

This strategy limits my risk and allows for unlimited profit potential. A long strangle, much like a straddle, is my preferred tool when I expect a lot of volatility in the near term.

Like the long put butterfly, the long strangle is one of those trades with a debit to enter the trade. This is a result of buying both a call and a put at the same time. Fortunately, you can buy out-of-the-money options at a great discount compared to buying options in the money or at the money.

I lose money when the underlying security falls between strike prices of the options I bought. In that case, both options expire worthless. I lose what I paid for those options plus the commissions. However, if the underlying security moves outside of those options, my profit potential is virtually unlimited.

My next article is part 4 in this series and features strategies 9-12.

Billy Williams is a 25-year veteran trader and author. For a free strategy guide, “Fundamentals for the Aspiring Trader”, and to learn more about profitable trading, go to www.stockoptionsystem.com.