Basic Option Strategies
What this domain tests
Basic strategies test payoff construction and risk-reward arithmetic: covered calls, protective puts, bull and bear vertical spreads, and collars. You must identify maximum profit, maximum loss and breakeven without drawing the payoff.
Core rules
- Covered call = long stock + short call. It caps upside above the strike but keeps downside; premium cushions losses.
- Protective put = long stock + long put. It sets a floor below the strike; cost is the put premium.
- Bull call spread = buy lower-strike call, sell higher-strike call, same expiry. Net debit; limited profit and loss.
- Bear put spread = buy higher-strike put, sell lower-strike put. Net debit; profits when the underlying falls.
- Breakeven for a long call = strike + premium; for a long put = strike − premium.
- Vertical spreads reduce cost and margin but also cap payoff; they are directional, not volatility-neutral.
Worked example
Buy the ₹100 call at ₹6 and sell the ₹105 call at ₹2, same expiry, lot size 100. Net debit = ₹4 per share, or ₹400 per lot. Maximum loss is the debit, ₹400, if the stock is at or below ₹100 at expiry. Maximum profit is (105 − 100) − 4 = ₹1 per share, or ₹100, if the stock is at or above ₹105. Breakeven = 100 + 4 = ₹104. At ₹104, the long call is worth ₹4 and the short call is worthless; the position returns the ₹4 debit. The spread is suitable when you expect a moderate rise, not a collapse or an explosive rally.
Traps
- Mixing up debit spreads and credit spreads; a bull call spread is normally a debit.
- Forgetting to subtract the net premium when computing spread maximum profit.
- Assuming a covered call removes downside risk; it only reduces it by the premium received.