Price of options strategy

Collar.

NOTE: This graph indicates profit and loss at expiration, respective to the stock value when you sold the call and bought the put.

The Strategy.

Buying the put gives you the right to sell the stock at strike price A. Because you’ve also sold the call, you’ll be obligated to sell the stock at strike price B if the option is assigned.

You can think of a collar as simultaneously running a protective put and a covered call. Some investors think this is a sexy trade because the covered call helps to pay for the protective put. So you’ve limited the downside on the stock for less than it would cost to buy a put alone, but there’s a tradeoff.

The call you sell caps the upside. If the stock has exceeded strike B by expiration, it will most likely be called away. So you must be willing to sell it at that price.

Options Guy's Tips.

Many investors will run a collar when they’ve seen a nice run-up on the stock price, and they want to protect their unrealized profits against a downturn.

Some investors will try to sell the call with enough premium to pay for the put entirely. If established for net-zero cost, it is often referred to as a “zero-cost collar.” It may even be established for a net credit, if the call with strike price B is worth more than the put with strike price A.

Some investors will establish this strategy in a single trade. For every 100 shares they buy, they’ll sell one out-of-the-money call contract and buy one out-of-the-money put contract. This limits your downside risk instantly, but of course, it also limits your upside.

You own the stock Buy a put, strike price A Sell a call, strike price B Generally, the stock price will be between strikes A and B.

NOTE: Both options have the same expiration month.

Who Should Run It.

Rookies and higher.

When to Run It.

You’re bullish but nervous.

Break-even at Expiration.

From the point the collar is established, there are two break-even points:

If established for a net credit, the break-even is current stock price minus net credit received. If established for a net debit, the break-even is current stock price plus the net debit paid.

The Sweet Spot.

You want the stock price to be above strike B at expiration and have the stock called away.

Maximum Potential Profit.

From the point the collar is established, potential profit is limited to strike B minus current stock price minus the net debit paid, or plus net credit received.

Maximum Potential Loss.

From the point the collar is established, risk is limited to the current stock price minus strike A plus the net debit paid, or minus the net credit received.

Ally Invest Margin Requirement.

Because you own the stock, the call you sold is considered “covered.” So no additional margin is required after the trade is established.

As Time Goes By.

For this strategy, the net effect of time decay is somewhat neutral. It will erode the value of the option you bought (bad) but it will also erode the value of the option you sold (good).

Implied Volatility.

After the strategy is established, the net effect of an increase in implied volatility is somewhat neutral. The option you sold will increase in value (bad), but it will also increase the value of the option you bought (good).

Check your strategy with Ally Invest tools.

Use the Profit + Loss Calculator to establish break-even points, evaluate how your strategy might change as expiration approaches, and analyze the Option Greeks.

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Learn trading tips & strategies.

from Ally Invest’s experts.

Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time.

Multiple leg options strategies involve additional risks, and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct.

Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. System response and access times may vary due to market conditions, system performance, and other factors. You alone are responsible for evaluating the merits and risks associated with the use of Ally Invest’s systems, services or products. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns.

Securities offered through Ally Invest Securities, LLC. MemberВ FINRAВ andВ SIPC. Ally Invest Securities, LLC is a wholly owned subsidiary of Ally Financial Inc.

Options Pricing.

Option pricing refers to the amount per share at which an option is traded. Options are derivative contracts that give the holder (the "buyer") the right, but not the obligation, to buy or sell the underlying instrument at an agreed-upon price on or before a specified future date. Although the holder of the option is not obligated to exercise the option, the option writer (the "seller") has an obligation to buy or sell the underlying instrument if the option is exercised.

Depending on the strategy, options trading can provide a variety of benefits, including the security of limited risk and the advantage of leverage. Another benefit is that options can protect or enhance your portfolio in rising, falling and neutral markets. Regardless of why you trade options – or the strategy you use – it's important to understand how options are priced. In this tutorial, we'll take a look at various factors that influence options pricing, as well as several popular options-pricing models that are used to determine the theoretical value of options.

How to Trade Options.

Options trading can be complex, even more so than stock trading. When you buy a stock, you decide how many shares you want, and your broker fills the order at the prevailing market price or at a limit price. Trading options not only requires some of these elements, but also many others, including a more extensive process for opening an account.

Indeed, before you can even get started you have to clear a few hurdles. Because of the amount of capital required and the complexity of predicting multiple moving parts, brokers need to know a bit more about a potential investor before awarding them a permission slip to start trading options.

Opening an options trading account.

Brokerage firms screen potential options traders to assess their trading experience, their understanding of the risks in options and their financial preparedness.

Before you can start trading options, a broker will determine which trading level to assign to you.

You’ll need to provide a prospective broker:

Investment objectives such as income, growth, capital preservation or speculation Trading experience, including your knowledge of investing, how long you’ve been trading stocks or options, how many trades you make per year and the size of your trades Personal financial information, including liquid net worth (or investments easily sold for cash), annual income, total net worth and employment information The types of options you want to trade.

Based on your answers, the broker assigns you an initial trading level (typically 1 to 4, though a fifth level is becoming more common) that is your key to placing certain types of options trades.

Screening should go both ways. The broker you choose to trade options with is your most important investing partner. Finding the broker that offers the tools, research, guidance and support you need is especially important for investors who are new to options trading.

For more information on the best options brokers, read our detailed roundup to compares costs, minimums and other features. Or answer a few questions and get a recommendation of which ones are best for you.

Consider the core elements in an options trade.

When you take out an option, you’re purchasing a contract to buy or sell a stock, usually 100 shares of the stock per contract, at a pre-negotiated price by a certain date. In order to place the trade, you must make three strategic choices:

Decide which direction you think the stock is going to move. Predict how high or low the stock price will move from its current price. Determine the time frame during which the stock is likely to move.

1. Decide which direction you think the stock is going to move.

This determines what type of options contract you take on. If you think the price of a stock will rise, you’ll buy a call option. A call option is a contract that gives you the right, but not the obligation, to buy a stock at a predetermined price (called the strike price) within a certain time period.

If you think the price of a stock will decline, you’ll buy a put option. A put option gives you the right, but not the obligation, to sell shares at a stated price before the contract expires.

2. Predict how high or low the stock price will move from its current price.

An option remains valuable only if the stock price closes the option’s expiration period “in the money.” That means either above or below the strike price. (For call options, it’s above the strike; for puts it’s below the strike.) You’ll want to buy an option with a strike price that reflects where you predict the stock will be during the option’s lifetime.

For example, if you believe the share price of a company currently trading for $100 is going to rise to $120 by some future date, you’d buy a call option with a strike price less than $120 (ideally a strike price no higher than $120 minus the cost of the option, so that the option remains profitable at $120). If the stock does indeed rise above the strike price, your option is in the money.

Similarly, if you believe the company’s share price is going to dip to $80, you’d buy a put option (giving you the right to sell shares) with a strike price above $80 (ideally a strike price no lower than $80 minus the cost of the option, so that the option remains profitable at $80). If the stock drops below the strike price, your option is in the money.

You can’t choose just any strike price. Option quotes, technically called option chains, contain a range of available strike prices. The increments between strike prices are standardized across the industry — for example, $1, $2.50, $5, $10 — and are based on the stock price.

The price you pay for an option has two components: intrinsic value and time value.

The price you pay for an option, called the premium, has two components: intrinsic value and time value. Intrinsic value is the difference between the strike price and the share price, if the stock price is above the strike. Time value is whatever is left, and factors in how volatile the stock is, the time to expiration and interest rates, among other elements. For example, suppose you have a $100 call option while the stock costs $110. Let’s assume the option’s premium is $15. The intrinsic value is $10 ($110 minus $100), while time value is $5.

This leads us to the final choice you need to make before buying an options contract.

3. Determine the time frame during which the stock is likely to move.

Every options contract has an expiration date that indicates the last day you can exercise the option. Here, too, you can’t just pull a date out of thin air. Your choices are limited to the ones offered when you call up an option chain.

Expiration dates can range from days to months to years. Daily and weekly options tend to be the riskiest and are reserved for seasoned option traders. For long-term investors, monthly and yearly expiration dates are preferable. Longer expirations give the stock more time to move and time for your investment thesis to play out.

A longer expiration is also useful because the option can retain time value, even if the stock trades below the strike price. An option’s time value decays as expiration approaches, and options buyers don’t want to watch their purchased options decline in value, potentially expiring worthless if the stock finishes below the strike price. If a trade has gone against them, they can usually still sell any time value remaining on the option — and this is more likely if the option contract is longer.

More about the types of options trades.

What's next?

Find the best broker for options traders.

Dig into options trading strategies.

Learn the essential options trading terms.

James F. Royal, Ph. D., and Dayana Yochim are staff writers at NerdWallet, a personal finance website. : jroyalnerdwallet, dyochimnerdwallet. Twitter: JimRoyalPhD, DayanaYochim.

This post has been updated.

Options Trading 101.

Options Trading 101.

5 Tips for Choosing an Options Broker.

5 Tips for Choosing an Options Broker.

Options trading can be complicated. But if you choose your options broker with care, you’ll quickly master how to conduct research, place trades and track positions.

Here’s our advice on finding a broker that offers the service and the account features that best serve your options trading needs.

1. Look for a free education.

If you’re new to options trading or want to expand your trading strategies, finding a broker that has resources for educating customers is a must. That education can come in many forms, including:

Online options trading courses. Live or recorded webinars. One-on-one guidance online or by phone Face-to-face meetings with a larger broker that has branches across the country.

It’s a good idea to spend a while in student-driver mode and soak up as much education and advice as you can. Even better, if a broker offers a simulated version of its options trading platform, test-drive the process with a paper trading account before putting any real money on the line.

2. Put your broker’s customer service to the test.

Reliable customer service should be a high priority, particularly for newer options traders. It’s also important for those who are switching brokers or conducting complex trades they may need help with.

Consider what kind of contact you prefer. Live online chat? ? Phone support? Does the broker have a dedicated trading desk on call? What hours is it staffed? Is technical support available 24/7 or only weekdays? What about representatives who can answer questions about your account?

Even before you apply for an account, reach out and ask some questions to see if the answers and response time are satisfactory.

3. Make sure the trading platform is easy to use.

Options trading platforms come in all shapes and sizes. They can be web - or software-based, desktop or online only, have separate platforms for basic and advanced trading, offer full or partial mobile functionality, or some combination of the above.

Visit a broker’s website and look for a guided tour of its platform and tools. Screenshots and video tutorials are nice, but trying out a broker’s simulated trading platform, if it has one, will give you the best sense of whether the broker is a good fit.

Some things to consider:

Is the platform design user-friendly or do you have to hunt and peck to find what you need? How easy is it to place a trade? Can the platform do the things you need, like creating alerts based on specific criteria or letting you fill out a trade ticket in advance to submit later? Will you need mobile access to the full suite of services when you’re on the go, or will a pared-down version of the platform suffice? How reliable is the website, and how speedily are orders executed? This is a high priority if your strategy involves quickly entering and exiting positions. Does the broker charge a monthly or annual platform fee? If so, are there ways to get the fee waived, such as keeping a minimum account balance or conducting a certain number of trades during a specific period?

4. Assess the breadth, depth and cost of data and tools.

Data and research are an options trader’s lifeblood. Some of the basics to look for:

A frequently updated quotes feed. Basic charting to help pick your entry and exit points. The ability to analyze a trade’s potential risks and rewards (maximum upside and maximum downside). Screening tools.

Those venturing into more advanced trading strategies may need deeper analytical and trade modeling tools, such as customizable screeners; the ability to build, test, track and back-test trading strategies; and real-time market data from multiple providers.

Check to see if the fancy stuff costs extra. For example, most brokers provide free delayed quotes, lagging 20 minutes behind market data, but charge a fee for a real-time feed. Similarly, some pro-level tools may be available only to customers who meet monthly or quarterly trading activity or account balance minimums.

5. Don’t weigh the price of commissions too heavily.

There’s a reason commission costs are lower on our list. Price isn’t everything, and it’s certainly not as important as the other items we’ve covered. But because commissions provide a convenient side-by-side comparison, they often are the first things people look at when picking an options broker.

A few things to know about how much brokers charge to trade options:

The two components of an options trading commission are the base rate — essentially the same as thing as the trading commission that investors pay when they buy a stock — and the per-contract fee. Commissions typically range from $3 to $9.99 per trade; contract fees run from 15 cents to $1.25 or more. Some brokers bundle the trading commission and the per-contract fee into a single flat fee. Some brokers also offer discounted commissions based on trading frequency, volume or average account balance. The definition of “high volume” or “active trader” varies by brokerage.

If you’re new to options trading or use the strategy only sparingly you’ll be well-served by choosing either a broker that offers a single flat rate to trade or one that charges a commission plus per-contract fee. If you’re a more active trader, you should review your trading cadence to see if a tiered pricing plan would save you money.

Of course, the less you pay in fees the more profit you keep. But let’s put things in perspective: Platform fees, data fees, inactivity fees and fill-in-the-blank fees can easily cancel out the savings you might get from going with a broker that charges a few bucks less for commissions.

There’s another potential problem if you base your decision solely on commissions. Discount brokers can charge rock-bottom prices because they provide only bare-bones platforms or tack on extra fees for data and tools. On the other hand, at some of the larger, more established brokers you’ll pay higher commissions, but in exchange you get free access to all the information you need to perform due diligence.

Dayana Yochim is a staff writer at NerdWallet, a personal finance website: : dyochimnerdwallet. Twitter: DayanaYochim.

Options Trading 101.

Disclaimer: NerdWallet has entered into referral and advertising arrangements with certain broker-dealers under which we receive compensation (in the form of flat fees per qualifying action) when you click on links to our partner broker-dealers and/or submit an application or get approved for a brokerage account. At times, we may receive incentives (such as an increase in the flat fee) depending on how many users click on links to the broker-dealer and complete a qualifying action.

10 Options Strategies to Know.

10 Options Strategies To Know.

Too often, traders jump into the options game with little or no understanding of how many options strategies are available to limit their risk and maximize return. With a little bit of effort, however, traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction.

10 Options Strategies To Know.

Too often, traders jump into the options game with little or no understanding of how many options strategies are available to limit their risk and maximize return. With a little bit of effort, however, traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction.

1. Covered Call.

Aside from purchasing a naked call option, you can also engage in a basic covered call or buy-write strategy. In this strategy, you would purchase the assets outright, and simultaneously write (or sell) a call option on those same assets. Your volume of assets owned should be equivalent to the number of assets underlying the call option. Investors will often use this position when they have a short-term position and a neutral opinion on the assets, and are looking to generate additional profits (through receipt of the call premium), or protect against a potential decline in the underlying asset's value. (For more insight, read Covered Call Strategies For A Falling Market.)

2. Married Put.

In a married put strategy, an investor who purchases (or currently owns) a particular asset (such as shares), simultaneously purchases a put option for an equivalent number of shares. Investors will use this strategy when they are bullish on the asset's price and wish to protect themselves against potential short-term losses. This strategy essentially functions like an insurance policy, and establishes a floor should the asset's price plunge dramatically. (For more on using this strategy, see Married Puts: A Protective Relationship . )

3. Bull Call Spread.

In a bull call spread strategy, an investor will simultaneously buy call options at a specific strike price and sell the same number of calls at a higher strike price. Both call options will have the same expiration month and underlying asset. This type of vertical spread strategy is often used when an investor is bullish and expects a moderate rise in the price of the underlying asset. (To learn more, read Vertical Bull and Bear Credit Spreads.)

4. Bear Put Spread.

The bear put spread strategy is another form of vertical spread​ like the bull call spread. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price. Both options would be for the same underlying asset and have the same expiration date. This method is used when the trader is bearish and expects the underlying asset's price to decline. It offers both limited gains and limited losses. (For more on this strategy, read Bear Put Spreads: A Roaring Alternative To Short Selling.)

Investopedia Academy "Options for Beginners"

Now that you've learned a few different options strategies, if you're ready to take the next step and learn to:

Improve flexibility in your portfolio by adding options Approach Calls as down-payments, and Puts as insurance Interpret expiration dates, and distinguish intrinsic value from time value Calculate breakevens and risk management Explore advanced concepts such as spreads, straddles, and strangles.

5. Protective Collar.

A protective collar strategy is performed by purchasing an out-of-the-money put option and writing an out-of-the-money call option at the same time, for the same underlying asset (such as shares). This strategy is often used by investors after a long position in a stock has experienced substantial gains. In this way, investors can lock in profits without selling their shares. (For more on these types of strategies, see Don't Forget Your Protective Collar and How a Protective Collar Works.)

6. Long Straddle.

A long straddle options strategy is when an investor purchases both a call and put option with the same strike price, underlying asset and expiration date simultaneously. An investor will often use this strategy when he or she believes the price of the underlying asset will move significantly, but is unsure of which direction the move will take. This strategy allows the investor to maintain unlimited gains, while the loss is limited to the cost of both options contracts. (For more, read Straddle Strategy A Simple Approach To Market Neutral . )

7. Long Strangle.

In a long strangle options strategy, the investor purchases a call and put option with the same maturity and underlying asset, but with different strike prices. The put strike price will typically be below the strike price of the call option, and both options will be out of the money. An investor who uses this strategy believes the underlying asset's price will experience a large movement, but is unsure of which direction the move will take. Losses are limited to the costs of both options; strangles will typically be less expensive than straddles because the options are purchased out of the money. (For more, see Get A Strong Hold On Profit With Strangles.)

8. Butterfly Spread.

All the strategies up to this point have required a combination of two different positions or contracts. In a butterfly spread options strategy, an investor will combine both a bull spread strategy and a bear spread strategy, and use three different strike prices. For example, one type of butterfly spread involves purchasing one call (put) option at the lowest (highest) strike price, while selling two call (put) options at a higher (lower) strike price, and then one last call (put) option at an even higher (lower) strike price. (For more on this strategy, read Setting Profit Traps With Butterfly Spreads . )

9. Iron Condor.

An even more interesting strategy is the iron condor. In this strategy, the investor simultaneously holds a long and short position in two different strangle strategies. The iron condor is a fairly complex strategy that definitely requires time to learn, and practice to master. (We recommend reading more about this strategy in Take Flight With An Iron Condor, Should You Flock To Iron Condors? and try the strategy for yourself (risk-free!) using the Investopedia Simulator.)

10. Iron Butterfly.

The final options strategy we will demonstrate here is the iron butterfly. In this strategy, an investor will combine either a long or short straddle with the simultaneous purchase or sale of a strangle. Although similar to a butterfly spread, this strategy differs because it uses both calls and puts, as opposed to one or the other. Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors will often use out-of-the-money options in an effort to cut costs while limiting risk. (To learn more, read What is an Iron Butterfly Option Strategy?)