Selling a Straddle: Generating Premium with Stock Ownership

A straddle sale involves writing a call and a put at the same strike price while simultaneously owning the underlying stock. This is known as a covered straddle because stock ownership reduces the risk of the short call assignment.

Example: Selling a Straddle on XYZ

• XYZ is trading at $51.
• Sell XYZ 50 Call for $5.
• Sell XYZ 50 Put for $4.
• Buy 100 shares of XYZ at $51.

Profit and Risk Analysis

• Maximum Profit = Total premium received + Strike price – Stock purchase price. This occurs if the stock remains at $50 at expiration, as both options expire worthless.
• Risk Considerations:
  • If XYZ rises sharply, the trader is obligated to sell the stock at $50, capping the upside.
  • If XYZ drops sharply, the put assignment forces the trader to buy at $50 while holding shares bought at $51, leading to losses beyond the premium collected.

When to Use a Covered Straddle

• In neutral markets, where large movements are unlikely.
• When looking to generate premium income while holding the stock.

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Basic Put Spreads: Managing Risk in Bearish and Bullish Markets

Put spreads involve buying and selling puts with different strike prices to define maximum profit and loss scenarios. There are two main types:

1. Bear Put Spread (Debit Spread): Profits when stock price falls.
2. Bull Put Spread (Credit Spread): Profits when stock price rises.

Bear Put Spread: Betting on a Decline

A bear put spread involves:

• Buying a put at a higher strike (more expensive).
• Selling a put at a lower strike (cheaper).

Example: Bear Put Spread on XYZ at $55

• Buy XYZ 60 Put for $7.
• Sell XYZ 50 Put for $2.
• Initial cost (debit) = $5 (7 – 2).

Profit and Risk Analysis

• Maximum Profit: Occurs when stock falls below $50 at expiration. Max profit=Difference in strikes−Initial debit=10−5=5($500)\Max profit = Difference in strikes – Initial debit = 10 – 5 = 5
• Max profit=Difference in strikes−Initial debit=10−5=5($500)
• Maximum Loss: The initial cost of $500.

This is a bearish strategy that limits risk compared to outright put buying.

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Bull Put Spread: Betting on Stability or a Rise

A bull put spread involves:

• Selling a put at a higher strike (more expensive).
• Buying a put at a lower strike (cheaper).

Example: Bull Put Spread on XYZ at $55

• Sell XYZ 60 Put for $7.
• Buy XYZ 50 Put for $2.
• Initial credit = $5 (7 – 2).

Profit and Risk Analysis

• Maximum Profit: If XYZ closes above $60, both puts expire worthless, and the trader keeps the $5 credit ($500 per contract).
• Maximum Loss: If XYZ closes below $50, the trader takes a $10 loss but retains the $5 credit, so the net loss is $500.

Key Considerations for Put Spreads

• Bear spreads are for declining markets but cap both gains and losses.
• Bull spreads work well in stable or slightly rising markets and generate income.

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Iron Condor: Profiting in Low-Volatility Markets

An Iron Condor is a neutral strategy that profits when a stock remains within a price range. It involves selling an out-of-the-money (OTM) put spread and an OTM call spread simultaneously.

Example: Iron Condor on XYZ at $120

• Buy 1 XYZ 135 Call for $0.50.
• Sell 1 XYZ 130 Call for $1.00.
• Sell 1 XYZ 110 Put for $1.00.
• Buy 1 XYZ 105 Put for $0.50.
• Total net credit = $1 per share ($100 per contract).

Profit and Risk Analysis

• Maximum Profit: If XYZ stays between $110 and $130, all options expire worthless, and the trader keeps the $100 credit.
• Maximum Loss: If XYZ moves outside the range ($105 or $135), the max loss is the difference between the strikes minus the initial credit received

When to Use an Iron Condor

• Low-volatility environments where stock movements are expected to be limited.
• Steady premium collection strategy with defined risk.

Trade-Offs

• Wider strike ranges reduce the probability of max loss but lower premium income.
• A tight range gives higher premium but increases the chance of assignment.

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Key Takeaways

Strategy	Market Outlook	Max Profit	Max Loss	Ideal Conditions
Selling a Straddle	Neutral	Premium received	Unlimited downside if stock crashes	Low volatility, strong stock ownership
Bear Put Spread	Bearish	Strike difference – initial debit	Initial debit	Stock expected to decline
Bull Put Spread	Bullish	Initial credit received	Strike difference – credit	Stock expected to stay stable
Iron Condor	Neutral (low vol.)	Initial credit received	Strike difference – credit	Stock stays within range