Equity and Index Options Explained

11

Option Spreads

Calls and puts can be combined in a wide variety of ways. Some of these combinations have become familiar enough to be recognised as option strategies. The following list, while no means exhaustive, contains some of the most widely used of these recognized option strategies. Any genuine option practitioner, whether broker, trader or analyst would recognise these strategies although the exact names of these strategies may vary from market to market:

Collars (aka fences, combos, min/max, etc.)

Call spreads and put spreads

Straddles and strangles

Butterflies and condors

Calendars and diagonals

The majority of these spreads are used primarily to speculate, the exception being the collar or fence. Of the strategies listed above, only the collar is a truly defensive strategy, a strategy used primarily to hedge an existing position in the underlying.

There are many more recognised option strategies than those listed above, often with ever more exotic names such as jelly-rolls and seagulls and Christmas trees, but we will focus upon the strategies listed above.

All of these option strategies have evolved for one of two reasons:

• To reduce the cost of owning options and/or
• To reduce the risk of selling options

Remember that the two main reasons for using options are protection (hedging an existing underlying position or holding) and speculation (risking money in order to make more money). As previously stated, of the strategies listed above, the only truly protective ...