DEFINITIONS AND STRATEGIES
Call Option – The buyer of a call option wants the price of the underlying instrument to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples).
Call options are most profitable for the buyer when the underlying instrument moves up, making the price of the underlying instrument closer to, or above, the strike price. The call buyer believes it’s likely the price of the underlying stock will rise by the exercise date. The risk is limited to the premium. The profit for the buyer can be very large, and is limited by how high stock rises. When the price of the underlying instrument surpasses the strike price, the option is said to be “in the money”.
Put option – A put option is the opposite of a call option. The buyer of a put option wants the price of the underlying instrument to decline in the future. The more the underlying stock declines, the more the put buyer profits.
Call Spread – Options spreads are the basic building blocks of many options trading strategies. A spread position is entered by buying and selling equal number of options of the same class on the same underlying security but with different strike prices or expiration dates.
Cover Call Strategy – An options strategy in which an investor holds a long position in a stock and writes (sells) call options on that stock in an attempt to generate increased income from the asset. When a stock is bought long and an option is sold against the stock, the investor receives income from receiving the option premium. This is also known as a buy-write. This strategy can produce a profit when the stock increases, or when the stock remains neutral.
Bull Spread – If an options spread is designed to profit from a rise in the price of the underlying security, it is a bull spread.
Bear Spread – A bear spread is a option spread where a favorable outcome is obtained when the price of the underlying security declines.
Selling An Option Spread (Credit Spread) – a credit spread, or net credit spread, involves a purchase of one option and a sale of another option in the same class and expiration but different strike prices. In the trade, the sale of the options is of greater monetary value than the purchase of the similar options in the spread, thus, the trade results in a credit (the investor receives money). Investors receive a net credit for entering the position, and want the spreads to narrow or expire for profit. If both options expire worthless, the trade is profitable because the investor received premium at the outset of the trade.