Options trading strategies

  • Strangles, straddles and covered calls are popular strategies with options traders. At City Index, we offer options on our indices, currencies and commodities markets.

    Strategy 1: Strangle

    Long strangle (buying a strangle)

    Short strangles involve the sale of a low strike put option and a high strike call option on the same underlying security with the same expiry dates.

    Short strangles are popular with option traders, because they allow you to potentially profit when market volatility is low and in a range-bound market.

    However, your profits are limited to the premium of the strangle and losses are potentially unlimited.

    Short strangle (selling a strangle)

    Long strangles are created by purchasing a low-strike put option and a high-strike call option on the same underlying security with the same expiry dates.

    A trader who owns a strangle can profit if the market is volatile and moves by more than a certain amount in either direction.

    The profit is potentially unlimited, the maximum loss is known at the time the trade is executed and will be equal to the total premium paid for the two options.

    Example of a short strangle (with a spread bet)

    Let’s imagine you:

    Sell a UK 100 Dec 6000 put option at a price of 90 for £10 per point.

    Sell a UK 100 Dec 7000 call option at a price of 45 for £10 per point.

    Best-case scenario: If the UK 100 expires between 6000 and 7000 on the expiry date, you could make a profit of £1,350 (90 x £10 + 45 x £10).

    Break-even points: You’ll break even if the UK 100 expires at 5865 (90 + 45 points below 6000) or at 7135 (90 + 45 points above 7000) on the expiry date.

    Worst-case scenario: If the UK 100 falls well below 5865 or rallies well above 7135, your loss will be equal to £10 for every point that the UK 100 expires below 5865 or above 7135.

    For example, if the UK 100 expires at 5700, your loss will be £1,650 ([6000 - 5700] x £10 per point - [90 + 45] x £10 per point).

    If you’re trading CFDs, 1 CFD = £1 per point, therefore 10 CFDs = £10 per point.

    Strategy 2: Straddle

    A straddle is similar to a strangle, except the strikes of the call and put options are the same.

    Short straddle (selling a straddle)

    A short straddle is the sale of both a put and a call option on the same underlying security with the same strike prices and the same expiry dates.

    Typically, this strategy is used by traders to profit in low volatility markets. Positions can be closed before the expiry date.

    You could make a profit at expiry if the market stays within a range based on the premium received from the straddle. But profits are limited to the premium of the straddle and losses are potentially unlimited.

    An investor might sell a straddle in a range-bound market or if he expects a market to stay at current levels.

    Long straddle (buying a straddle)

    A long straddle is created by purchasing a put and a call option on the same underlying security with the same strike prices and expiry dates.

    Typically, an investor will buy a straddle if he thinks the market will be volatile.

    You would make a profit if the underlying price moves, either up or down, by more than the premium you paid for the strategy.

    Profits from being long a straddle are potentially unlimited. Losses are limited to the premium paid for the two options and so the straddle has what’s known as ‘limited risk’.

    Example of a long straddle (on a spread bet)

    Let’s say you:

    Buy a UK 100 Dec 6500 put at 220 for £10 per point.

    Buy a UK 100 Dec 6500 call at 200 for £10 per point.

    Best-case scenario: If the UK 100 falls well below 6080 or rallies well above 6920, your profit will be equal to £10 for every point that the UK 100 expires below 6080 or above 6920.

    Break-even points: You’ll break even if the UK 100 expires at 6080 (220+200 points below 6500) or at 6920 (220+200 points above 6500) on the expiry date.

    Worst-case scenario: If the UK 100 expires at 6500 on the expiry date, your loss will be limited to £4,200 (220 x £10 + 200 x £10).

    If you’re trading CFDs, 1 CFD = £1 per point, therefore 10 CFDs = £10 per point.

    Strategy 3: Covered call

    This is a strategy where you already own the underlying instrument. If you believe the underlying instrument will stay the same, or you’re happy to sell it if the price increases, then you could sell a call option against it.

    If the price of the underlying instrument stays the same or increases, the covered call strategy will give you a profit equal to the premium (price x stake) of the call option.

    At the same time, if the underlying instrument falls in price, you won’t lose as much as you would have done if you hadn’t sold the call option.

    Example of a covered call (spread bet)

    Let's say you currently own £100 per point of BP from 400p.

    You sell a BP Mar 420p call option at a price of 25 for £100 per point.

    If BP were to expire around 400p in March, you’d make £2,500 (25 x £100) more than you would have if you hadn't sold the call.

    If by expiry BP settles above 420p, you’d make a profit of £4,500.

    If BP were to settle at 420p in March, you’d make £4,500 (420-400 x £100 = £2,000 profit from the underlying BP position. 25 x £100 = £2,500 profit from the call option).

    If by expiry BP has fallen, you’d make a loss. However the loss would be £2,500 less than the amount you’d lose if you hadn't sold the call option.

    If BP were to fall only a tiny amount by expiry, to say 380p, you would still make a £500 profit (£2,500 profit from the call option. £2,000 loss on the underlying BP position).

    If you’re trading CFDs, 1 CFD = £1 per point (equivalent to 100 shares), therefore 100 CFDs = £100 per point (this is equivalent to 10,000 shares).

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