Gain a better understanding of various options strategies with the material below. This information covers vertical spreads, naked spreads, a call vs put strategy, and more. When you're ready to begin investing, Open your options trading account at Firstrade today and continue reading our guide to learn more about the various options strategies!
I sold a naked call and then bought the same call. Is my naked call now covered?
Generally, if someone purchases the same call that was sold, it's likely that the two transactions would be matched as opening and closing transactions and the position would be eliminated. While not common, there may be some strategies where an investor wishes to remain long and short on the same contract. If this is the case, the naked margin requirement would be eliminated, but the position still bears the risk assignment on the short call option.
Can an individual person be both long and short the exact same option at the same time?
Generally, if you simultaneously buy options and sell the same number of options within the same series, you will have a flat position with regard to that option series. If you conduct the trades in different accounts or with different brokers, the positions would not be offset within the same account, but since you would be simultaneously long and short the same asset, you would still be flat from an economic point of view - your total position would net out to zero.
Whether you conduct the purchase and sale simultaneously, or at different times, your total position is viewed from a net long, net short, or flat position.
Financially, if the transactions are conducted concurrently, you would be buying at the ask price and selling at the bid price, immediately placing you at a net loss due to the bid/ask spread. Additionally, if you were to place an order to buy and sell the same security at the same time, which results in conducting both sides of the transaction with yourself, this would be considered a “wash sale”, as there would be no change of beneficial ownership, and is a violation of various rules and regulations.
In summary, there would be little or no advantage to being both long and short the same, exact option. The two positions would net to zero, there could potentially be a violation of exchange rules, and when you consider the commissions coupled with the bid/ask spreads, there would probably be more cost than benefit.
Can I perform a spread by purchasing an at the money LEAPS® call, and selling a front month out of the money call?
Yes, the trading strategy you described is also known as a "diagonal call spread." When considering implementing this strategy, you should be aware of the risks associated with the strategy, along with the (potential) rewards. In the worst case scenario, should you be assigned on the front month call and then exercise your LEAPS® to cover the assignment, your loss would be the net debit paid to establish the position less the difference between the strike prices of the two options.
It’s more difficult to establish a maximum gain for this strategy, which in many ways resembles the Covered Call. The best case scenario is for the stock to go sideways or gradually rise over the life of the LEAPS® call, thus allowing you to roll out your front-month option every month at a credit. Review the various LEAPS® strategies, including spreads in the LEAPS® section.
What is the difference between a Call and a Put - and why does my broker tell me that I can't sell a Put when I'm long the stock?
An equity option is a contract. The call contract conveys to its holder the right, but not the obligation, to buy shares of the underlying security at a specified price (the strike price) on or before a given date (expiration day). The put contract conveys to its holder the right, but not the obligation, to sell shares of the underlying security at the strike price on or before a given date (expiration day). After this given expiration date, the option contract ceases to exist. If assigned, the seller of an option is, in turn, obligated to sell (in the case a call) or buy (in the case of a put) the shares to (or from) the buyer of the option at the specified price.
In the case of a covered call, the investor sells a call option contract while at the same time owning an equivalent number of shares of the underlying stock. If an investor is assigned an exercise notice on the written contract he/she sells an equivalent number of shares at the call's strike price.
As for why your broker might have concerns about selling a put option while long the underlying stock, if the investor is assigned an exercise notice on the written contract he/she buys an equivalent number of shares at the put's strike price, effectively getting "longer" the underlying stock.
What are the advantages of "vertical spreads"? And, are there any disadvantages?
One advantage is knowing what the risks and rewards are for that position. The vertical spread consists of buying one option and selling another with a different strike but both expiring in the same month.
Another advantage of a vertical spread versus a single option position is that it is possible to put a cap on the amount of risk the option writer (seller) assumes, and decrease the costs of the purchase if you are an option buyer.
One obvious disadvantage is that while limiting risk, the investor also sets a limit on their profit. So, the investor would put a cap on profit potential. Also, the investor should be aware that commissions and interest charges can effect the profitability of all spread strategies. It is suggested that the investor consult a tax advisor concerning the tax consequences of any spread strategy. Further, there are occasions where certain types of corporate actions may impact the profit/loss profile of a spread. Extraordinary dividends, tender offers and even mergers can alter the dynamics of a spread.
Can you please provide an explanation of profit and loss diagrams for options? I am having difficulty interpreting their meaning.
An explanation is offered in Understanding Profit and Loss Graphs (PDF | 497k).
What is a long straddle?
A Long Straddle is a combination of buying a Call and buying a Put on the same underlying security, both with the same strike price and expiration. Together, they produce a position that should profit if the stock makes a big move either up or down. Typically, investors buy the straddle because they predict a big price move and/or a great deal of volatility in the foreseeable future. For example, the investor might be expecting an important court ruling in the next quarter, the outcome of which will be either very good news or very bad news for the stock. However, since the straddle involves two premiums and two commission charges, for the position to be profitable, the move would need to be large enough to cover both premiums and commissions.
Please explain the Long Strangle strategy.
The long strangle is simply the simultaneous purchase of a long call and a long put on the same underlying security with both options having the same expiration but where the put strike price is lower than the call strike price. This strategy may prove beneficial when the investor feels large price movement, either up or down, is about to happen but uncertain of the direction. For instance, a strangle may be considered when an earnings announcement is forthcoming, the outcome of which will introduce large price swings in the underlying in either direction. However, since the strangle involves two premiums, for the position to be profitable, the move would need a corresponding option price increase that is enough to cover the two premiums paid for the position.
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