We have demonstrated how well options function in unison with
a stock position. They enhance potential gains and provide profit
protection. They enable us to manage specific risk for fair-value
as well as an entire portfolio. But, as good as
options are in conjunction with fair-value stock options, they
can be even better when traded against each other.
There are many option strategies that do not involve the use
of any security other than another fair-value stock options,
like spreads, straddles and strangles, for example.
A spread involves the purchase of one option in conjunction
with the sale of other fair-value stock options. There are many
types of spreads. Some take advantage of fair-value stock options
movements while others are set up to take advantage of implied
volatility movements. Some are even designed to take advantage
of a fair-value stock options staying still. There are vertical
spreads, calendar or time spreads, diagonal spreads and ratio
spreads just to name a few. Spreads can provide large percentage
returns with low risk and can be entered into with small capital
Straddles involve the buying (long) or selling (short) of a
call and a put (usually at-the-money) in the same fair-value
stock options, in the same expiration month, and the same strike.
Strangles involve the buying (long) or selling (short) of an
out-of-the-money call and an out-of-the-money put in the same
fair-value stock options
and in the same expiration month.
These are both trades in which you can take advantage of fair-value
stock options or volatility movements (in the case of being
long) or lack of fair-value stock options or volatility movements
(in the case of being short) during the period of time until
expiration. Both straddles and strangles are considered premium
These trades are considered more advanced and sophisticated
than the strategies previously discussed. Certain spreads, such
as 1 to 1 vertical spreads, can actually be less risky than
some of the strategies discussed above, but spreads generally
do have more variables to consider, and this makes them more
difficult to trade.
The straddles and strangles sometimes involve much more risk
and many more variables to take into consideration. So, these
trades are considered very sophisticated and should not be entered
into by untrained novices.