Advanced Options Strategies (Level 3)

Although options may not be appropriate for everyone, they can be among the most flexible of investment choices. Whether you're hedging or seeking to grow your investments, you can use options to help reach the goals you set for your portfolio.

This page is an educational tool that can help you learn about the options strategies available with Level 3 on Robinhood. Before you begin trading options, it's worth taking the time to identify an investment strategy that makes sense for you.

Depending on your position, it’s possible for you to lose the principal you invest, or potentially more – So, it can be helpful to learn more about the different strategies before diving in.

Call Credit Spreads

The Basics

What’s a call credit spread?

A call credit spread is an options trading strategy you might use when you think a stock price will stay relatively flat or fall before a certain date (i.e., you have a neutral to bearish outlook). It comes with a risk of limited losses and the potential for limited profit. The strategy involves one short call and one long call on the same underlying stock.

When you open a call credit spread, you sell a call (at a lower strike price) and buy a call (at a higher strike price) both expiring on the same day. This strategy is also known as a bear call spread or a short call spread.

When might I use this strategy?

You may consider a call credit spread when you expect the price of the underlying stock to remain relatively flat or fall before a certain date (i.e., you have a neutral to bearish outlook). If your expectation is met, this strategy can allow you to earn a limited profit while capping your potential losses.

At the outset, you receive a premium for the contract you sold (the short call) and pay a premium for the contract you bought (the long call). You start with a net credit since the premium you collect for the short call is greater than the premium you pay for the long call. This net credit is the maximum profit you can earn using this strategy.

But if things don’t go as expected, your potential losses are limited, too. If the price of the underlying stock sharply increases, the long call constrains how much money you could lose. (It gives you the right to buy shares at a higher price if you are obligated to cover an assignment on the short call.)

How is a call credit spread different from only selling a call?

Only selling a call is another choice if you have a relatively bearish to neutral outlook on a stock — You may think the price of the underlying stock will fall in the future, or at least not reach the strike price before the option expires. If the stock price closes below the strike price on the expiration date, the option you sold should expire worthless, allowing you to pocket the entire premium.

However, unlike a call credit spread, only selling a call on stock you don’t own may involve the risk of unlimited losses — This strategy is also known as selling a naked or uncovered call. Here’s how: If the stock soars above the strike price and the buyer of the option decides to exercise it, you have no choice but to buy the stock at the prevailing market price to supply the shares. You lose the difference between the strike price and the market price, which theoretically, can be infinite, since there’s no limit on how high a stock price could go.

Please note: Robinhood does not allow uncovered or “naked” positions.

With a call credit spread, you can benefit if the stock price falls, but you also cap your potential losses in case the stock price climbs. That’s because you also bought the right to purchase the stock, albeit at a higher strike price than the option that you sold.

Calculations

Can I see an example?

With a call credit spread, your maximum potential gain is the net credit you received when you opened the spread. Remember, this is what you’re left with after buying a call and selling a call to construct the spread. You realize your maximum potential profit if the stock price at expiration is equal to or below the strike price of the short call. If this happens, both calls expire worthless, and you keep the net credit.

Setting up a Call Credit Spread

For example, imagine the fictional MEOW company is trading at $100 per share. You’re pessimistic about the company’s outlook and decide to open a call credit spread on MEOW. Here’s how it works:

  • You sell one call option with a strike price of $110, receiving a $5 premium per share (this is the short call).
  • At the same time, you buy one call option with a strike price of $115, paying a premium of $2 per share (this is the long call).
  • Both calls have the same expiration date.
  • Note: The long call is less expensive than the short call because it’s further out of the money.

Maximum potential gain

The net credit you receive is $3 per share ($5 received - $2 paid). An options contract typically represents 100 shares, so your maximum potential profit is $3 multiplied by 100 shares, or $300. You can achieve this if the stock trades at $110 or less at expiration.

Maximum potential loss

But, if the stock rallies, you may experience a loss. The maximum loss you can experience on a call credit spread is the difference between the strike prices minus the net credit received. (I.e., You buy the underlying shares at the higher strike price and are obligated to sell them at the lower strike price for a loss, but get to keep the net credit.) This theoretical maximum loss may occur if the stock price is equal to or above the strike price of the long call — the higher strike price — at expiration.

In the MEOW example, the difference between the strike prices ($115 - $110) is $5. Subtracting the net credit received ($3) leaves $2. So, the maximum amount you could lose per share is $2. If each contract represents 100 shares, that means potentially losing up to $200. You would lose this amount if the stock price is $115 or higher when the options expire.

Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices, number of contracts involved, and whether the stock pays a dividend.

What’s the breakeven point at expiration?

You break even with a call credit spread if, on the expiration date, the stock price closes at the strike price of the short call (the lower strike price) plus the net credit received.

In the MEOW example, the strike price of the short call is $110, and the net credit is $3. Adding $110 and $3 comes to $113. So you will break even if MEOW’s stock price closes at $113 on the contracts’ expiration date (the short call gets assigned and you sell MEOW shares at $110 while buying shares at $113, and the long call expires worthless). If the stock price falls anywhere below $113, you should profit.

Monitoring

I opened a call credit spread. What could happen next?

Can I close a call credit spread?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of a call credit spread, you would simultaneously buy-to-close the short call option (the one you initially sold to open) and sell-to-close the long call option (the one you initially bought to open). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

What could happen at expiration?

  • If the stock price is equivalent to or lower than the short strike price, then both options should expire worthless, allowing you to keep the entire net credit you received when you opened the spread.
  • If the stock price is above the short strike price and below the long strike price, then the long call option should expire worthless. However, you’d likely be assigned on the short call option. In this scenario, you might experience an overall gain or loss — This depends on the price at which the shares are bought back due to the assignment and the amount of net credit you received when you opened the spread.
  • If the stock price is above the long strike price, both options should expire in the money. This means that the short call would be assigned and the long call should be exercised. This would result in a trader realizing their maximum potential loss on the position.

Note: These scenarios assume your position has not been closed out by Robinhood.

Can I exercise my long call in a call credit spread?

Exercising a call option means purchasing the associated underlying shares (typically, 100 shares per contract). You can exercise your long call within a call credit spread if you have sufficient funds to do so. Remember, the shares you purchase will be held as collateral for your short call until it is closed, expires worthless, or is assigned (in which case you have to sell your shares). This helps prevent you from being exposed to the risks of an uncovered position — that is, having a short call option without having the necessary collateral.

What are some potential edge cases?

For call credit spreads, two of the more common edge cases involve early assignment risk and dividend risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. If a trader holding a call credit spread is assigned on the short call option, the trader can take one of the following actions by the end of the following trading day:

  • Exercise their long call option (thereby buying the shares at the strike price)
  • Buy the shares at market price.

In either circumstance, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Dividend risk

Dividend risk is the risk that a trader will be assigned on a short call option the night before the ex-dividend date (and thus, owe the dividend to the buyer). This is one of the biggest risks of trading spreads with a short call option and the result would be a greater loss (or lower gain) than the maximum potential gain and loss scenarios described above. Traders can avoid this by closing their position before the end of the regular-hours trading session the night before the ex-dividend date. Learn more about dividend risks here.

Put Credit Spreads

The Basics

What’s a put credit spread?

A put credit spread is an options trading strategy you might use when you think a stock price will hold relatively steady or rise before a certain date (i.e., you have a neutral to bullish outlook). It comes with a risk of limited losses and the potential for limited profit. The strategy involves one short put and one long put on the same underlying stock.

When you open a put credit spread, you sell a put (at a higher strike price) and buy a put (at a lower strike price), both expiring on the same day. This strategy is also called a bull put spread or a short put spread.

When might I use this strategy?

You may consider a put credit spread when you expect the price of the underlying stock to remain flat or increase before a certain date (i.e., you have a neutral to bullish outlook). If your expectation is met, this strategy can allow you to earn a limited profit while capping your potential losses.

At the outset, you receive a premium for the contract you sold (the short put) and pay a premium for the contract you bought (the long put). You start with a net credit, since the premium you collect for the short put is greater than the premium you pay for the long put. This net credit is the maximum profit you can earn using this strategy.

But if things don’t go as expected, your potential losses are limited, too. If the price of the underlying stock sharply decreases, the long put limits how much money you could lose (It gives you the right to sell shares at a lower price if you are obligated to cover an assignment on the short put.)

How is a put credit spread different from only selling a put?

Only selling a put is another choice if you have a relatively bullish to neutral outlook on a stock — You may think the price of the underlying stock will climb in the future, or at least not fall below the strike price before the option expires. If the stock closes above the strike price on the expiration date, the option expires worthless, allowing you to keep the premium as profit.

Yet compared to a put credit spread, only selling a put can involve risk of relatively greater losses. Here’s how: If the stock price plummets below the strike price and the buyer of the option decides to exercise it, you have no choice but to buy the underlying stock at the strike price to satisfy the put contract. This means you might have to pay far above the prevailing market price for the stock. Technically, there’s a limit on how much you could lose — After all, a stock price can’t go below $0. But there’s the potential for significant losses, while the possible reward is limited.

With a put credit spread, you can benefit if the stock price rises, but you also limit your losses in case the stock price falls. That’s because you also bought the right to sell the stock, albeit at a lower strike price than the option you sold.

Calculations

Can I see an example?

With a put credit spread, your maximum potential gain is the net credit you received when you opened the spread. Remember, this is what you’re left with after buying a put and selling a put to construct the spread. You should realize this maximum profit if the stock price is equal to or above the strike price of the short put at expiration. If this happens, both puts should expire worthless, and you’d keep the full net credit.

Setting up a put credit spread

Let’s see how this works with the fictional PURR company, now trading at $110 per share. You’re optimistic about the company’s future and decide to open a put credit spread on PURR. Here’s how it works:

  • You sell a put option with a strike price of $95, receiving a $4 premium per share (this is the short put).
  • At the same time, you buy a put option with a strike price of $90, paying a $2 premium per share (this is the long put).
  • Both puts have the same expiration date.
  • Note: The long put is cheaper because it’s further out of the money.

Maximum potential gain

The maximum potential gain is the net credit you receive, which is $2 per share ($4 received - $2 paid). An options contract typically represents 100 shares, so your maximum potential gain is $2 multiplied by 100 shares, or $200. This should happen if PURR trades at $95 or higher at expiration.

Maximum potential loss

If the stock price falls, you may experience a loss. The maximum potential loss is the difference between the higher and the lower strike prices, minus the net credit received. This may occur if the market price is at or below the strike price of the long put — the option with a lower strike price — at expiration.

In the PURR example, the difference between the strike prices ($95 - $90) is $5. Subtracting the net credit received ($2) leaves $3. So, the maximum amount you could potentially lose per share is $3. If each contract represents 100 shares, that means potentially losing up to $300. You would lose this amount if the stock price is $90 or lower at expiration.

Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices and number of contracts involved.

What’s the breakeven point at expiration?

You break even with a put credit spread if, on the expiration date, the stock price closes at or below the strike price of the short put (the higher strike price) minus the net credit received.

Let’s go back to our PURR example. The strike price of the short put ($95) minus the net credit received ($2) is $93. So if PURR closes at $93 on the spread’s expiration date, you will neither gain nor lose money. If the stock price goes above $93, you should make a profit; if it dips below the point, you’ll lose money.

Monitoring

I opened a put credit spread. What could happen next?

Can I close a put credit spread?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of a put credit spread, you would simultaneously buy-to-close the short put option (the one you initially sold to open) and sell-to-close the long put option (the one you initially bought to open). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

What could happen at expiration?

  • If the stock price is equal to or higher than the short strike price, then both options should expire worthless, allowing you to keep the entire net credit you received when you opened the spread.
  • If the stock price is below the short strike price and above the long strike price, then then the long put option should expire worthless. However, you would likely be assigned on the short put option. In this scenario, you might experience an overall profit or loss — this depends on the price at which the shares you were assigned are sold and the amount of net credit you collected when you opened the spread.
  • If the stock price is below the long strike price, both options should expire in the money. This means that the short put would be assigned and the long put would be exercised. This would result in a trader realizing their maximum potential loss on the position.

Note: These scenarios assume your position has not been closed out by Robinhood.

Can I exercise my long put in a put credit spread?

Exercising a put requires selling the associated underlying shares (typically, 100 shares per contract). You can exercise your long put within a put credit spread if you already own enough shares to deliver on the exercise (that is, selling the shares at the strike price). Remember, if you choose to do so, the cash generated from the sale of shares will be held as collateral for your short put until it is closed, expires worthless, or is assigned (in which case you buy the shares). This helps prevent you from being exposed to the risks of an uncovered or “naked” position — that is, having a short put option without having the necessary cash to cover it.

What are some potential edge cases?

For put credit spreads, one of the more common edge cases involves early assignment risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. If a trader holding a put credit spread is assigned on the short put option, the trader can take one of the following actions by the end of the following trading day:

  • Exercise their long put option (thereby selling the shares at the strike price)
  • Sell the shares at market price.

In either circumstance, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Call Debit Spreads

The Basics

What’s a call debit spread?

A call debit spread is an options trading strategy you might use when you think a stock price will rise moderately before a certain date (i.e., you have a bull-ish outlook). It comes with a risk of limited losses and the potential for limited profit. The strategy involves one long call and one short call, both on the same underlying stock and with the same expiration date.

When you open a call debit spread, you buy a call (at a lower strike price) and sell a call (at a higher strike price), both expiring on the same day. This strategy is also known as a long call spread or bull call spread.

When might I use this strategy?

You may consider a call debit spread when you expect a stock to rise moderately in the near future, but before a certain date. You hope to profit if that happens, without the risk and expense of buying an equivalent number of shares outright or only a long call. Instead, you can open a call debit spread, giving yourself the opportunity to realize a limited profit if your expectation comes true and capping your losses if it doesn’t.

When you open a call debit spread, you pay a premium for the contract you buy (the long call) and receive a premium for the contract you sell (the short call). You begin with a net debit since the premium you paid for the long call is greater than the premium you collected for the short call. (This helps explain why this options strategy is called a call debit spread.)

If the stock price increases, you have the potential to profit, up to a point. The value of your long call option could increase, but you might be assigned on their short call. On the other hand, if the stock price falls, you only risk losing the net debit you paid upfront (as both calls may expire worthless). The amount you paid for a call is partially offset by the amount you received for selling one. This allows you to reduce your potential losses.

How is a call debit spread different from only buying a call?

If you have a bullish outlook on a stock, you might consider only buying a call option — You may think the price of the underlying stock will increase in the future, or at least rise beyond the strike price by an amount equal to the premium paid before the option expires (don’t worry, we’ll talk more about the breakeven point later). If this happens, you can realize your gain by closing the position. In theory, with a call option, your potential gain is unlimited, since a stock price can rise to virtually any number. Meanwhile, if the option expires worthless, your loss is limited to the total premium you paid for the call.

Similarly, if you open a call debit spread, you buy a call in hopes that the price of the underlying stock will rise. But, by selling a call option at the same time (at a higher strike price), you pay a lower premium overall to open the position. While this can allow you to reduce your costs, it also limits your potential gains.

Calculations

Can I see an example?

With a call debit spread, your maximum potential gain is the difference between the high strike price and low strike price, minus the net debit. (Remember, the net debit is what you spent overall in buying a call and selling a call to open the spread.) You should realize this maximum gain if the stock price is equal to or above the strike of the short call — the one with a higher strike price — at or before expiration. If this happens, you would likely exercise the long call and be assigned on the short call.

Opening a call debit spread

Let’s consider the fictional CATZ company, currently trading at $110 per share. You expect the stock to rally somewhat and decide to open a call debit spread on CATZ. Here’s how it works:

  • You buy a call option at a strike price of $110, paying a $5 premium per share (this is the long call).
  • Simultaneously, you sell a call option at a strike price of $120, receiving a $2 premium per share (this is the short call).
  • Both calls have the same expiration date.

Your net debit is $3 per share ($5 paid - $2 received), or $300 for the entire spread, assuming each contract represents 100 shares.

Maximum potential gain

To determine your maximum potential gain, start by subtracting the lower strike price from the higher one ($120 - $110 = $10). Next, subtract the net debit from that number ($10 - $3 net debit = $7). So, the most you can earn is $7 per share. If each contract is for 100 shares, your maximum profit is $700. This would happen if CATZ closed at $120 or higher at expiration, and both calls are exercised.

Maximum potential loss

Let’s see what happens if your expectation is unmet, and the stock price dips instead. Your maximum loss is the net debit you paid to open the spread. This occurs if the market price of the stock closes at or below the strike price of the long call — the one with a lower strike price — on the expiration date. In this scenario, both calls should expire worthless.

Going back to CATZ, recall that you paid a net debit of $3 per share. If each contract represents 100 shares, you could lose up to $300. This would happen if CATZ closes at $110 or lower at expiration.

Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices and number of contracts involved.

What’s the breakeven point at expiration?

To figure out when you would break even with a call debit spread, add the strike price of the long call (the one with a lower strike price) to the net debit. If your spread position expires when the stock closes at the breakeven point, then you neither realize a gain nor a loss.

Let’s consider the CATZ example again. The strike price of the long call ($110) plus the net debit to open the spread ($3) is $113. So if, your spread position expires when CATZ closes at exactly $113, then you neither make nor lose money. If the price exceeds $113, you could profit. If CATZ remains below $113 until the options expire, then you may experience a loss.

Monitoring

I opened a call debit spread. What could happen next?

Can I close a call debit spread?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of a call debit spread, you would simultaneously sell-to-close the long call option (the one you initially bought to open) and buy-to-close the short call option (the one you initially sold to open). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

What could happen at expiration?

  • If the stock price is equivalent to or lower than the long strike price, then both options should expire worthless. This should result in a trader realizing their maximum potential loss on the position (the net debit they paid to open the spread).
  • If the stock price is above the long strike price and below the short strike price, then then the short call option should expire worthless. In this scenario, you might experience a profit or loss.This depends on the price at which the shares are sold if the long call is exercised and the amount of the net debit you paid when you opened the spread.
  • If the stock price is above the short strike price, both options should expire in the money. This means that the short call should be assigned and the long call should be exercised. You should realize your maximum potential gain on the position

Note: These scenarios assume your position has not been closed out by Robinhood.

Can I exercise my long call in a call debit spread?

Exercising a call requires purchasing the associated underlying shares (typically, 100 shares per contract). You can exercise your call option within a call debit spread if you have sufficient funds to do so. Remember, your shares will be held as collateral for your short call until it is closed, expires worthless, or is assigned. This helps prevent you from being exposed to the risks of an uncovered position — that is, being left with a short call option without having the necessary collateral to cover it.

What are some potential edge cases?

For call debit spreads, two of the more common edge cases involve early assignment risk and dividend risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. If a trader holding a call debit spread is assigned on the short call option, the trader can take one of the following actions by the end of the following trading day:

  • Exercise their long call option (thereby buying the shares at the strike price)
  • Buy the shares at market price.

In either circumstance, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Dividend risk

Dividend risk is the risk that a trader will be assigned on a short call option the night before the ex-dividend date (and thus, owe the dividend to the buyer). This is one of the biggest risks of trading spreads with a short call option and the result would be a greater loss (or lower gain) than the maximum potential gain and loss scenarios described above. Traders can avoid this by closing their position before the end of the regular-hours trading session the night before the ex-dividend date. Learn more about dividend risks here.

Put Debit Spreads

The Basics

What’s a put debit spread?

A put debit spread is an options trading strategy you might use when you think a stock price will fall moderately before a certain date (i.e., you have a bear-ish outlook). It comes with a risk of limited losses and the potential for limited profit. The strategy involves one short put and one long put, both on the same underlying stock and with the same expiration date.

When you open a put debit spread, you sell a put (with a lower strike price) and buy a put (with a higher strike price), both expiring on the same day. This strategy is also called a bear put spread or a long put spread.

When might I use this strategy?

You may consider a put debit spread when you expect a stock to fall moderately in the near future, but before a certain date. You hope to capitalize on your expectation, without the risk of relatively greater losses and expense of only buying a put option. Instead, you can open a put debit spread, giving yourself the opportunity for a limited profit if your expectation comes true and capping your losses if it doesn’t.

When you open a put debit spread, you pay a premium for the contract you buy (the long put) and receive a premium for the contract you sell (the short put). You begin with a net debit since the premium you paid for the long put is greater than the premium you collected for the short put. (This helps explain why this options strategy is called a put debit spread.)

If the stock price falls, you have the potential to profit, up to a point. The value of your long put may increase, but you might be assigned on your short put. On the other hand, if the stock price rises, you only risk losing the net debit you paid upfront (as both puts may expire worthless). The amount you paid for a put is partially offset by the amount you received for selling one. In exchange for capping potential losses, you are accepting a limit on your potential gains as well.

How is a put debit spread different from only buying a put?

If you have a bearish outlook on a stock, you might consider only buying a put option — You may think the price of the underlying stock will decrease in the future, or at least fall below the strike price by an amount equal to the premium paid before the option expires (don’t worry, we’ll talk more about the breakeven point later). If this happens, you could potentially realize a profit by closing the position. Your maximum potential gain is quite large, as a stock price can theoretically fall all the way to $0. However, this is an unlikely outcome. Meanwhile, if the option expires worthless, your loss is limited to the total premium you paid for the put.

Similarly, if you open a put debit spread, you buy a put in hopes that the price of the underlying stock will decline. But, by selling a put at the same time (at a lower strike price), you pay a lower premium overall to open the position. While this can allow you to reduce your costs, it also limits your potential gains.

Calculations

Can I see an example?

With a put debit spread, your maximum potential gain is the difference between the high strike price and the low strike price, minus the net debit. (Recall, the net debit is what you spent overall in buying a put and selling a put to construct the spread.) You should realize this maximum potential gain if the stock price is equal to or below the strike of the short put — the one with a lower strike price — at expiration. If this happens, you would likely exercise the long put and be assigned on the short put.

Opening a put debit spread

Let’s take a look at the fictional FURR company, currently trading at $110 per share. You expect the stock to drop somewhat and decide to open a put debit spread on FURR. Here’s how it works:

  • You sell a put option at a strike price of $100, receiving a $3 premium per share (this is the short put).
  • At the same time, you buy a put option at a strike price of $110, paying a $7 premium per share (this is the long put).
  • Both options expire on the same day.

Your net debit is $4 per share ($7 paid - $3 received), or $400 for the entire spread, assuming each contract represents 100 shares.

Maximum potential gain

To figure out your maximum potential gain, start by subtracting the lower strike price from the higher one ($110 - $100 = $10). Next, subtract the net debit from that number ($10 - $4 = $6). So the most you can earn is $6 per share. If each contract is for 100 shares, your maximum profit is $600. This would happen if FURR trades at $100 or less at expiration, and both puts are exercised.

Maximum potential loss

Let’s see what can happen if your expectation is unmet, and the stock climbs instead. Your maximum potential loss is the net debit you paid to open the spread. This occurs if the market price of the stock closes above the strike price of the long put — the one with a higher strike price — on the expiration date. In this scenario, both puts should expire worthless.

Going back to FURR, remember that you paid a net debit of $4 per share. If each contract represents 100 shares, you could lose up to $400. This would happen if FURR trades at $110 or higher at expiration.

Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices and number of contracts involved.

What’s the breakeven point at expiration?

To figure out when you would break even with a put debit spread, subtract the net debit from the strike price of the long put (the one with a higher strike price). If your spread position expires when the stock closes at the breakeven point, then you should neither realize a profit nor a loss.

Let’s go back to the FURR example. The strike price of the long put ($110) minus the net debit per share ($4) is $106. So if your spread position expires when FURR closes at exactly $106, then you should neither make nor lose money. If the price ends up below $106, you could profit. If FURR remains above $106 until the options expire, then you may experience a loss.

Monitoring

I opened a put debit spread. What could happen next?

Can I close a put debit spread?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of a put debit spread, you would simultaneously sell-to-close the long put option (the one you initially bought to open) and buy-to-close the short put option (the one you initially sold to open). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

What could happen at expiration?

  • If the stock price is equivalent to or higher than the long strike price, then both options should expire worthless. This would result in a trader realizing their maximum potential loss on the position (the net debit they paid to open the spread).
  • If the stock price is above the short strike price and below the long strike price, then the short put option would likely expire worthless. In this scenario, you might realize a gain or loss — This depends on the price at which the shares are bought if the long put is exercised and the amount of the net debit you paid when you opened the spread.
  • If the stock price is below the short strike price, both options should expire in the money. This means that the short put would be assigned and the long put should be exercised, allowing you to realize your maximum potential gain on the spread.

Note: These scenarios assume your position has not been closed out by Robinhood.

Can I exercise my long put in a put debit spread?

Exercising a put requires selling the associated underlying shares (typically, 100 shares per contract). You can exercise your put within a put debit spread if you already own enough shares to deliver on the exercise (that is, selling the shares at the strike price). Remember, if you choose to do so, a portion of the cash generated from the sale of shares will be held as collateral for your short put until it is closed, expires worthless, or is assigned (in which case you buy shares). This helps prevent you from being exposed to the risks of an uncovered position — that is, having a short put option without having the necessary cash to cover it.

What are some potential edge cases?

For put debit spreads, one of the more common edge cases involves early assignment risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. By the end of the following trading day, a trader can take one of the following actions in order to cover the assigned short put:

  • Exercise their long put option (thereby selling the shares at the strike price)
  • Sell the shares at market price.

In each of these circumstances, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Iron Condors

The Basics

What’s an iron condor?

An iron condor is an options trading strategy you might use if you have a neutral outlook on a stock (i.e., you think the stock price won’t rise or fall very much). It typically involves potential for limited profit and risk of limited losses. This strategy combines a put credit spread and a call credit spread both expiring on the same day.

Usually, when you open an iron condor, all four options begin out of the money, with the strike prices of the long and short puts (aka put credit spread) set below the current stock price and the strike prices of the long and short calls (aka call credit spread) set above the stock price. The difference between the long call and short call strikes is equivalent to the difference between the short put and the long put strikes.

When might I use this strategy?

You might consider an iron condor when you expect a stock to remain steady for a certain period of time. By setting up a put credit spread below the current stock price and a call credit spread above the current stock price, you can benefit if the stock price remains relatively flat (i.e., it stays between the short put strike price and the short call strike price). When charted on a profit/loss diagram, the trade roughly resembles a bird, with the long and short puts representing the left wing and the long and short calls creating the right wing.

You can maximize your return if the stock price closes within this target range on the expiration date, with all four options expiring worthless. In that case, your gain would be the total net credit.

You would break even on the trade when the stock price either falls below the level of the short put strike by an amount equal to the net credit per share or rises above the short call strike by an amount equal to the net credit per share. A trader’s maximum potential loss occurs if, at expiration, the stock price closes either below the long put strike or above the long call strike.

How is an iron condor different from only selling a call credit spread or a put credit spread?

The iron condor is a non-directional, or neutral, trading strategy. By comparison, a call credit spread is a neutral-to-bearish strategy — that is, you might open a call credit spread if you anticipate a decline in a stock’s price. Conversely, a put credit spread is a neutral-to-bullish strategy — You might open a put credit spread if you expect the underlying stock to increase in price.

However, all these trades have some things in common. First, they all attempt to generate income from the sale of options. Additionally, they’re all structured to limit downside risk, since theoretically, the most money you could lose is the difference between the two strikes on either the call spread or put spread minus the net premium per share, multiplied by 100.

Calculations

Can I see an example?

Opening an iron condor

To figure out how much someone could potentially gain or lose from an iron condor strategy, let’s look at an example from the fictional MEOW company. If MEOW shares are currently trading at $100 and the person expects them to trade within a range of $10 in either direction over the next month, they could set up an iron condor aimed at profiting during this period.

To build the left wing of the iron condor, they might sell a put option expiring in one month, with a strike price at the bottom of the expected range ($90), receiving a premium of $2 per share. To complete the spread, they would buy a put option expiring on the same day with a strike price of $80, paying a premium of $1 per share.

To build the right wing of the iron condor, they would sell a call option expiring in one month with a strike price at the top of the expected range ($110), receiving a premium of $2 per share. To complete the spread, they would buy a call option expiring on the same day with a strike price of $120, paying a premium of $1 per share.

Maximum Potential Gain

The trader should realize their maximum potential gain if MEOW shares close between $90 and $110 when the options expire in a month. In this case, all four options should expire worthless and the trader should keep the entire net credit.

In detail: By adding up $2 per share from selling the put option and $2 per share from selling the call option, and subtracting $1 per share for buying the put option and $1 per share for buying the call option, they would receive a net credit of $2 per share ($2 + $2 - $1 - $1 = $2 net credit per share). Since options contracts typically represent 100 shares each, the trader’s maximum potential gain would be $200.

Maximum Potential Loss

On the other hand, the trader should realize their maximum potential loss if, when the options expire, MEOW shares close either below the lower put strike ($80) or above the upper call strike ($120).

In detail: To calculate the maximum potential loss on the expiration date, consider two scenarios.

If the stock price closes below $80, calculate the difference between the strike prices of the put options ($90-$80=$10). Then, subtract the net credit per share ($2) you received upfront ($10-$2=$8). This equates to a loss of $8 per share, or $800 total. Since both call options are out of the money at close, they should expire worthless.

If the stock price closes above $120, calculate the difference between the strike prices of the call options ($120-$110=$10). Then subtract the net credit per share ($2) you received upfront ($10-$2=$8). This equates to a loss of $8 per share, or $800 total. Since both put options are out of the money at close, they should expire worthless.

Keep in mind that this is a theoretical example, so actual gains or losses could be greater.

What are the breakeven points at expiration?

Because an iron condor consists of two spreads, the trading strategy has two breakeven points, one on each of the wings. If the stock price drops, then the breakeven point is the strike of the short put (higher put strike) minus the net credit per share. If the stock price rises, then the breakeven point is the strike of the short call (lower call strike) plus the net credit per share.

In the MEOW example above, if the stock price drops, the breakeven point is $90 - $2 = $88. If the stock price rises, the breakeven point is $110 + $2 = $112. So, if MEOW closes at either $88 or $112 on the expiration date, this iron condor should neither make nor lose money. Between the range of $88 to $112, this strategy should generate a profit.

Monitoring

I opened an iron condor. What could happen next?

Can I close an iron condor?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of an iron condor, you would simultaneously buy-to-close the short put option (the one you initially sold) and sell-to-close the long put option (the one you initially bought). At the same time, you would buy-to-close the short call option (which you initially sold) and sell-to-close the long call option (the one you initially bought). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

What could happen at expiration?

  • If the stock price is below the long put strike price, a trader may realize their maximum potential loss. In this scenario, the long put should be exercised and the short put would likely be assigned. Meanwhile, both call options should expire worthless.
  • If the stock price is above the long call strike price, a trader may realize their maximum potential loss. In this scenario, the long call should be exercised and the short call would likely be assigned. Meanwhile, both put options should expire worthless.
  • If the stock price is in between the short put and short call strike prices, then you should realize your maximum gain (the net credit you received when you opened the spread). That’s because all four options should expire worthless.
  • If the stock price is between the long put strike and short put strike, you might experience an overall gain or loss — This depends on the price at which the assigned shares are sold and the amount of net credit you received when you opened the spread. In this case, both calls should expire worthless.
  • If the stock price is between the short call and long call strike, you might experience an overall gain or loss — This depends on the price at which the shares are bought back due to the assignment and the amount of net credit you received when you opened the spread. In this case, both puts should expire worthless.

Note: These scenarios assume your position has not been closed out by Robinhood.

How does time decay affect the position?

Options tend to lose value with the passage of time, which is a good thing for iron condors. An iron condor is made up of two credit spreads, both of which become more profitable as the expiration date approaches, as long as the stock price remains within the two breakeven points.

However, if the stock price rises or falls far enough so that either of the short options becomes in the money, the trade will likely start losing money as the expiration draws closer.

Time decay is measured by theta, which you can learn more about here.

How does implied volatility affect the position?

Since the iron condor is a non-directional trade that someone might use when they expect the stock price to stay neutral, a decrease in implied volatility (IV) is typically beneficial.

When IV increases, this typically raises the value of an option, which is good for a long option position and bad for a short option position. The iron condor is made up of two short credit spreads, so a decrease in IV should make the overall position more profitable.

Implied volatility is measured by vega, which you can learn more about here.

What are some potential edge cases?

For iron condors, two of the more common edge cases involve early assignment risk and dividend risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. By the end of the following trading day, a trader can take one of the following actions:

If assigned on the short call...

  • Exercise their long call option (thereby buying the shares at the strike price)
  • Buy the shares at market price.

If assigned on the short put...

  • Exercise their long put option (thereby selling the shares at the strike price)
  • Sell the shares at market price.

In any of these circumstances, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Dividend risk

Dividend risk is the risk that a trader will be assigned on a short call option the night before the stock’s ex-dividend date (and thus, owe the dividend to the buyer). This is one of the biggest risks of trading spreads with a short call option and the result would be a greater loss (or lower gain) than the maximum potential loss and maximum potential gain scenarios described above. Traders can avoid this risk by closing their position before the end of the regular-hours trading session the night before the ex-dividend date. Learn more about dividend risks here.

Calendar Spreads

The Basics

What is a calendar spread?

A calendar spread is an options trading strategy in which you open a short position and a long position on the same underlying stock at the same strike price, but with different expiration dates. It is often referred to as a horizontal spread because the only difference between the two contracts is their expiration dates.

In the case of a calendar spread, you sell a near-term option and buy a long-term option, both with the same strike price. This strategy involves the potential for limited profit and a risk of limited losses.

When might I use a calendar spread?

You may consider a long put calendar spread if you have a neutral to bullish outlook in the near-term. In other words, you may expect the underlying stock price to remain steady or slightly increase in the near-term.

You may consider a long call calendar spread if you have a neutral to bearish outlook in the near-term. In other words, you may expect the underlying stock price to remain steady or slightly decrease in the near-term.

You may open a calendar spread during times of lower volatility in the hopes of benefitting from a spike in implied volatility, assuming all other factors remain equal.

How is a calendar spread different from a vertical spread?

As previously mentioned, the only difference between the contracts used in a calendar spread is their expiration dates. By comparison, the only difference between the contracts used in a vertical spread (e.g., credit or debit spreads) is their strike prices.

Calculations

Can I see an example?

First, it’s important to note that it’s impossible to explicitly calculate the maximum potential gain or loss on a calendar spread because we cannot predict how the market will perform after the short option’s expiration date.

In this example, we examine a long put calendar spread and calculate potential gains (and potential losses) at the short put’s expiration date. We assume you will exercise your long put in case your short put gets assigned, so we do not account for any potential slippage (i.e., if you were to trade out of the assigned shares and the long put separately).

Imagine that you want to use a long put calendar spread when trading options on the fictional MEOW company, whose shares are currently trading at $100:

  • You sell a near-term put with a strike price of $90 (receiving a $2 premium per share)
  • You buy a long-term put with a strike price of $90 (paying a $5 premium per share)
  • Each option has a different expiration date
  • You open the calendar spread at an overall cost of $3 per share, or a net debit of $300. Remember, an options contract typically represents 100 shares of the underlying stock.

Let’s fast-forward. We’re now at the short put’s expiration date:

In-The-Money

If the stock closes below the short put’s strike price, and you exercise the long put option to offset the short put assignment, then your theoretical loss would be the $300 you paid to open the calendar spread.

At-The-Money

If the stock closes at the short put’s strike price, the short put should expire worthless, allowing you to keep the premium. Market dynamics become more of a factor for the long put. Since the stock price dropped, the long put would likely increase in value — let’s say to $6 per share, which represents a gain of $1 from the original premium ($5). If you sell the long put the following trading day for $6, then your total theoretical gain is $300, or the credit from the expired short put ($2 premium 100 shares = $200) plus the gain in the long put premium ($1 gain 100 shares = $100).

Out-Of-The-Money

If the stock closes above the short put’s strike price, the short put should again expire worthless, allowing you to keep the premium. In this scenario though, the stock price has increased so the long put would likely decrease in value — let’s say to $4 per share, which represents a $1 loss from the original premium ($5). If you sell your long put the following trading day for $4, then your total theoretical gain would be $100, or the credit from the expired short put ($2 premium 100 shares = $200) minus the change in the long put premium ($1 loss 100 shares = -$100).

As you can see in the above example, your profit is maximized when the underlying stock closes at the strike price at expiration. Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices and number of contracts involved.

What is the break-even point at the short put’s expiration?

In theory, a calendar spread has two breakeven points. One is higher and the other is lower than the strike price. But there’s no simple way of calculating them, because the breakeven points depend on various factors such as the options’ strike price, the stock price at the short put’s expiration, and the level of volatility. Since breakeven points in calendar spreads are pretty difficult to calculate, it’s important to analyze your trades before placing this type of order.

Monitoring

I opened a calendar spread. What could happen next?

Can I close a calendar spread?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of a calendar spread, you would simultaneously buy-to-close the option with the near-term expiration (the one you initially sold to open) and you would sell-to-close the option with the later expiration (the one you initially bought to open). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

Based on the long put calendar spread example above, what could happen at the expiration of the near-term put?

  • If the stock price is below the near short strike, then the short put should be assigned and you could either exercise the long put or sell the shares you were assigned by the end of the following trading day. This would result in a trader potentially realizing their maximum loss, which is the net debit they paid to open the spread. (This is assuming the trader didn’t have enough buying power to cover the assignment.)
  • If the stock price is at the near short strike, then the short put should expire worthless. If the trader sells the long put, then they could benefit from both the credit received from the expired short put and a potential increase in the long put’s premium.
  • If the stock price is above the near short strike, then the short put would expire worthless. The trader can sell the long put, whose value would have likely decreased due to the rise in the stock price — So, their overall gain might be less than if the stock price were at the near short strike.

Note: These scenarios assume your position has not been closed out by Robinhood.

How does time decay affect the position?

Generally, buyers of calendar spreads benefit from time decay if the underlying stock price stays close to the strike price, assuming all else remains equal. That’s because the near-term option is more sensitive to time decay (meaning it loses value faster as time passes) than the long-term option. Even if the near-term option expires worthless, the long-term option should still have some value since there’s time remaining before its expiration.

Time decay is measured by theta, which you can learn more about here.

How does implied volatility affect the position?

When implied volatility (IV) increases, this typically raises the value of an option, which is beneficial for a long option position and harmful for a short option position. Generally, buyers of calendar spreads benefit from increases in IV, assuming all else remains equal. That’s because the long-term option is slightly more sensitive to increases in IV than the near-term option.

Implied volatility is measured by vega, which you can learn more about here.

What are some potential edge cases?

For calendar spreads, common edge cases may include early assignment risk and dividend risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. By the end of the following trading day, a trader can take one of the following actions in order to cover the assigned short option:

If assigned on a short call on the long call calendar spread...

  • Exercise their long call option (thereby buying the shares at the strike price)
  • Buy the shares at market price.

If assigned on a short put on the long put calendar spread...

  • Exercise their long put option (thereby selling the shares at the strike price)
  • Sell the shares at market price.

In each of these circumstances, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Dividend risk

(Note: This applies to long call calendar spreads)

Dividend risk is the risk that a trader will be assigned on a short call option the night before the ex-dividend date (and thus, owe the dividend to the buyer). This is one of the biggest risks of trading spreads with a short call option and the result would be a greater loss (or lower gain) than the potential maximum gain and loss scenarios described above. Traders can avoid this by closing their position before the end of the regular-hours trading session the night before the ex-dividend date. Learn more about dividend risks here.

Iron Butterflies

The Basics

What’s an iron butterfly?

An iron butterfly is an options trading strategy you might use if you have a neutral outlook on a stock. It typically involves potential for limited profit and risk of limited losses. The strategy essentially combines a put credit spread (a short put and a long put) and call credit spread (a short call and a long call).

More specifically, an iron butterfly consists of a long call (at a higher strike price), a long put (at a lower strike price), and a short call and put (both at the same middle strike price). The upper and lower strike prices (the “wings”) are equidistant from the middle strike price (the “body”), and all four options have the same expiration date. This strategy can also be thought of as the combination of a short straddle and a long strangle, or a call credit spread and put debit spread.

When might I use this strategy?

You might consider an iron butterfly when you have a neutral outlook on a stock, meaning that you expect minimal movement in the underlying stock price over a certain period of time. The long strikes are typically out of the money and the short strikes are typically at the money. When charted on a profit/loss diagram, the trade roughly resembles a butterfly, with the long and short puts representing the left wing and the long and short calls creating the right wing.

You maximize your potential return if the stock remains at the middle strike price and all four options expire worthless, allowing you to keep the entire net credit received.

You would break even if the stock price at expiration is equivalent to the middle strike price plus (or minus) the net credit received per share. Your maximum potential loss occurs if, at expiration, the stock price closes either below the long put strike or above the long call strike.

How is an iron butterfly different from only selling a call credit spread or a put credit spread?

Selling a call credit spread is a neutral-to-bearish strategy, meaning you expect the price of the underlying stock to decline, while selling a put credit spread is a neutral-to-bullish strategy, meaning you expect the price of the underlying stock to rise. Each of these strategies consist of just two options, a long and a short, as opposed to the four options in an iron butterfly. As mentioned before, the iron butterfly is a neutral strategy in which you anticipate the stock price to remain relatively flat over a period of time. It’s also important to note that if the stock price has moved past the break-even prices at expiration, you would likely experience losses.

However, all these trades have some things in common. First, they all attempt to generate income from the sale of options. Additionally, they’re all structured to limit downside risk, since theoretically, the most money you could lose is the difference between the two strikes on either the call spread or the put spread, minus the net premium per share, multiplied by 100.

Calculations

Can I see an example?

To figure out how much someone could potentially gain or lose from an iron butterfly strategy, let’s look at an example from the fictional MOYE company, whose shares are currently trading at $100.

Imagine that a trader wants to use a short iron butterfly. The trader sells a short call and a short put with strike prices of $100 (receiving premiums of $3 per share and $4 per share, respectively) and simultaneously buys a long call with a strike price of $110 (paying a $1 premium per share) and a long put with a strike price at $90 (also paying a $1 premium per share). Remember, they all have the same expiration date. Therefore, the trader receives a net credit of $5 per share ($3 + $4 - $1 - $1 = $5) when opening this position.

Maximum Potential Gain

Your maximum potential gain should occur when the stock price closes at the short put and short call strike price on the expiration date.

In our example, you should realize your maximum potential gain if the stock price closes at the $100 strike price on the expiration date. In this case, all four options should expire worthless and you would keep the entire net credit of $500, assuming each contract represents 100 shares.

Maximum Potential Loss

Your maximum potential loss should occur when the stock price closes below the long put strike price or above the long call strike price, assuming the widths of each spread are the same. If they are different, the maximum potential loss could be greater, corresponding to the width of the wider spread.

In our example, you should realize your maximum potential loss if, when the options expire, MOYE shares close either below the lower put strike ($90) or above the upper call strike ($110).

In detail: To calculate the maximum potential loss on the expiration date, consider two scenarios.

If the stock price closes below $90, calculate the difference between the strike prices of the put options ($100 - $90 = $10). Then, subtract the net credit per share you received upfront ($10 - $5 = $5). This equates to a loss of $5 per share, or $500 in total. Since both of the call options are out of the money at the close, they should expire worthless.

If the stock price closes above $110, calculate the difference between the strike prices of the call options ($110 - $100 = $10). Then subtract the net credit per share you received upfront ($10 - $5 = $5). This equals a loss of $5 per share, or $500 in total. Since both of the put options are out of the money, they should expire worthless.

Keep in mind, this is a theoretical example. Actual gains and losses will depend on factors such as the prices and number of contracts involved.

What are the breakeven points at expiration?

Because an iron butterfly consists of two spreads, the trading strategy has two breakeven points, one on each of the wings. If the stock price drops, then the breakeven point is the strike of the short put (higher put strike) minus the net credit per share. If the stock price rises, then the breakeven point is the strike of the short call (lower call strike) plus the net credit per share.

In the MOYE example above, if the stock price drops, the breakeven point is $100 - $5 = $95. If the stock price rises, the breakeven point is $100 + $5 = $105. So, if MOYE closes at either $95 or $105 on the expiration date, this iron butterfly should neither make nor lose money. Between the range of $95 to $105, this strategy should generate a profit.

Monitoring

I opened an iron butterfly. What could happen next?

Can I close an iron butterfly?

Closing a spread means exiting the position that you opened. You can do this by taking the opposite actions that you took to open the position. In the case of an iron butterfly, you would simultaneously buy-to-close the short put and call options (the ones you initially sold) and sell-to-close the long put and call options (the ones you initially bought). In general, you can close a spread up until 4:00 pm ET on its expiration date on Robinhood. You may consider closing the spread if you want to realize your gains or prevent further losses.

What could happen at expiration?

  • If the stock price is below the long put strike price, a trader may realize their maximum potential loss. In this scenario, the long put should be exercised and the short put would likely be assigned. Meanwhile, both call options should expire worthless.
  • If the stock price is above the long call strike price, a trader may realize their maximum potential loss. In this scenario, the long call should be exercised and the short call would likely be assigned. Meanwhile, both put options should expire worthless.
  • If the stock price is at the short put and short call strike price, then you should realize your maximum gain (the net credit you received when you opened the spread). That’s because all four options should expire worthless.
  • If the stock price is between the long put strike and short put strike, you might experience an overall gain or loss — This depends on the price at which the assigned shares are sold and the amount of net credit you collected when you opened the spread. In this case, both calls should expire worthless.
  • If the stock price is between the short call and long call strike, you might experience an overall gain or loss — This depends on the price at which the shares are bought back due to the assignment and the amount of net credit you collected when you opened the spread. In this case, both puts should expire worthless.

How does time decay affect the position?

Options tend to lose value with the passage of time, which is a good thing for iron butterflies. An iron butterfly is made up of two credit spreads, both of which become more profitable as the expiration date approaches, as long as the stock price remains within the two breakeven points.

However, if the stock price rises or falls far enough so that either of the short options becomes in the money, the trade will likely start losing money as the expiration draws closer.

Time decay is measured by theta, which you can learn more about here.

How does implied volatility affect the position?

Since the iron butterfly is a non-directional trade that someone might use when they expect the stock price to stay neutral, a decrease in implied volatility (IV) is typically beneficial.

When IV increases, this typically raises the value of an option, which is beneficial for a long option position and harmful for a short option position. The iron butterfly is made up of two short credit spreads, so a decrease in IV should make the overall position more profitable.

Implied volatility is measured by vega, which you can learn more about here.

What are some potential edge cases?

For iron butterflies, two of the more common edge cases involve early assignment risk and dividend risk.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. By the end of the following trading day, a trader can take one of the following actions:

If assigned on the short call...

  • Exercise their long call option (thereby buying the shares at the strike price)
  • Buy the shares at market price.

If assigned on the short put...

  • Exercise their long put option (thereby selling the shares at the strike price)
  • Sell the shares at market price.

In any of these circumstances, their account may display a reduced or negative buying power temporarily as a result of the early assignment. Exercise of the long call should typically be settled within 1 to 2 trading days, and restore buying power partially or fully. Learn more about early assignments here.

Dividend risk

Dividend risk is the risk that a trader will be assigned on a short call option the night before the stock’s ex-dividend date (and as a result, owe the dividend to the buyer). This is one of the biggest risks of trading spreads with a short call option and the result would be a greater loss (or lower gain) than the maximum potential loss and maximum potential gain scenarios described above. Traders can avoid this risk by closing their position before the end of the regular-hours trading session the night before the ex-dividend date. Learn more about dividend risks here.

Box Spreads

What is a box spread?

A box spread is an options strategy created by opening a call spread and a put spread with the same strike prices and expiration dates.

Example #1

Sell to open 1 ABC Call $11 3/22/2019

Buy to open 1 ABC Call $10 3/22/2019

Buy to open 1 ABC Put $11 3/22/2019

Sell to open 1 ABC Put $10 3/22/2019

Example #2

Sell to open 1 XYZ Call $25 3/22/2019

Buy to open 1 XYZ Call $26 3/22/2019

Sell to open 1 XYZ Put $26 3/22/2019

Buy to open 1 XYZ Put $25 3/22/2019

Why aren’t box spreads allowed on Robinhood?

Box spreads are often mistaken for an arbitrage opportunity because you may be able to open a box spread position for less than its hypothetical minimum gain. These positions, however, have hidden dividend risk that could lead to losing much more money than expected. Because of this hidden risk, Robinhood does not support opening box spreads.

Disclosures

Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Robinhood Financial does not guarantee favorable investment outcomes and there is always the potential of losing money when you invest in securities, or other financial products. Investors should consider their investment objectives and risks carefully before investing. To learn more about the risks associated with options, please read the Characteristics and Risks of Standardized Options before you begin trading options. Please also be aware of the risks listed in the following documents: Day Trading Risk Disclosure Statement and FINRA Investor Information. Examples contained in this article are for illustrative purposes only. Supporting documentation for any claims, if applicable, will be furnished upon request.

Reference No. 1312317
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The 3-minute newsletter with fresh takes on the financial news you need to start your day.


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