4. Complex Trades—Part 1

The preceding chapter focused on covered trades that limit the potential loss of a short option position. Covered trades also provide downside protection for the complementary long position. However, this downside protection is limited to the value of the short option, and that value is realized only at expiration. These dynamics can be problematic for stock investors seeking more balanced positions in an unstable market.

Option traders generally solve this problem by structuring pure option positions that do not involve stock. Rather than purchasing 1,000 shares of stock and selling a call that is worth $2.50, an option trader might choose to purchase a $5.00 call and sell a $2.50 call at a more distant strike price. ...

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