Options Strategies and Position Management
Domain 3 - Options Strategies and Position Management
This domain tests whether you can construct a strategy, state its maximum gain, maximum loss, and breakeven without hesitation, and manage an existing position through assignment, rolling, or expiration.
Core structures
- Covered call: long stock + short call. Gain is capped at strike minus purchase price plus premium; downside is reduced only by the premium.
- Protective put: long stock + long put. Acts as insurance; cost is the premium, and it sets a floor at the strike.
- Vertical spreads: buy a lower-strike call and sell a higher-strike call (bull call spread, debit) or the reverse (bear call spread, credit). Max loss on a debit spread is the net debit.
- Long straddle/strangle: profit requires movement larger than total premium; theta works against the position.
- Collar: long put plus short call, often near zero cost, capping both directions.
Worked example
Buy the 50 call at $4.00 and sell the 55 call at $1.50. Net debit $2.50. Maximum gain = (55 − 50) − 2.50 = $2.50, or $250 per spread. Maximum loss = $250. Breakeven = 50 + 2.50 = $52.50.
Management
- An in-the-money short call should be watched before ex-dividend dates; early assignment is likely.
- Rolling up and out collects additional premium but can widen risk if the stock reverses.
- Do not let a spread expire with the short leg in the money and the long leg worthless because of a pin at the strike.
Traps
- Quoting breakeven for a credit spread without adding or subtracting the credit correctly.
- Treating a covered call as a hedge that removes downside risk.
- Forgetting that a short straddle has unlimited loss on the call side.