Basic Options Strategies (Level 2)

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 2 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.

Buying a Call

The Basics

What is buying a call?

Buying a call option (aka a “long call”) means opening a contract that gives you the right, but not the obligation, to buy shares of a stock at a certain price (the “strike price”) up until a set date (“expiration date”). In exchange for this right (known as the ability to “exercise” the option) you pay an upfront cost (the “premium”). A typical long call option offers the right to buy 100 shares of the underlying stock.

Because you have this right, it is beneficial for the stock price to increase in value. Your potential gain is theoretically infinite, while your risk of potential losses is limited to the premium you paid.

Here’s some lingo to describe how your long call option is performing relative to the stock price:

  • In-the-money: The stock price is above the strike price
  • At-the-money: The stock price is at the strike price
  • Out-of-the-money: The stock price is below the strike price

When might I use this strategy?

You might consider buying a call if you seek to benefit from an upward movement in a stock price (i.e., you have a bullish outlook), without actually owning the underlying shares. Your maximum potential gain is unlimited, because theoretically there’s no cap on how high a stock price can rise. On the other hand, if the stock price is below the strike price at expiration, your option expires worthless. When this happens, you would realize your maximum potential loss, which is the premium you paid upfront.

How is buying a call option different from buying shares in a company?

Instead of buying a call on a company you think will increase in value, you can buy shares in the company itself. While both strategies can give you upside exposure on an equivalent number of shares, there are some key differences. First, options have an expiration date, whereas shares do not — in other words, you can only exercise or sell your call until its expiration date, but shares typically do not have the same time constraints or risks. A call option can and may expire worthless. Second, you generally need less upfront capital to buy a call option than to buy shares to gain an equivalent level of exposure. As such, options can magnify your gains or losses based on your initial investment.

What are factors to consider when buying a call?

  • Expiration date: If you want to either sell or exercise your option, you must do so by this date. If you don’t, the option expires, and you no longer have the right to buy the underlying stock at the strike price. Assuming all other factors are constant, the further away an option’s expiration date, the lower your risk of loss.That’s because there’s more time for the stock price to potentially rise. For that reason, options with later expiration dates are likely to have higher premiums.

  • Strike price: This is the price you pay for the underlying stock if you choose to exercise the option, regardless of the price at which the stock is trading (“prevailing market price”). Assuming all other factors are constant, a call option with a higher strike price typically involves a greater risk of loss than a call option with a lower strike price. That’s because the stock would have to rise more for the call to become profitable.

  • Premium: This is the price you pay to buy the call. The higher the premium (i.e. the more the option costs), the more the stock price will have to rise for you to make a profit. Also, the more you pay for the call, the more you could potentially lose.

  • Contract: Each option typically represents 100 shares. The more contracts you buy the greater your exposure to potential gains and losses on the position.

Calculations

Can I see an example?

Let’s take a look at the fictional MEOW company, whose shares are currently trading at $110. Since you expect MEOW shares to rise, you decide to pay a $2 premium per share (or $200 in total) to buy one call option on MEOW. This gives you the right to purchase 100 MEOW shares at a strike price of $120.

Potential Gains or Losses at Expiration

If, at expiration, MEOW shares exceed the strike price plus premium paid per share, you can potentially profit on your long call. In our example, if MEOW rises above $122 ($120 strike price + $2 premium) and you exercise (and sell shares) or sell your option, then you should make a profit. Theoretically, your maximum gain is unlimited, since MEOW could rise to any number. Meanwhile, your potential maximum loss should be limited to the premium you paid upfront ($2 per share * 100 shares = $200).

MEOW rises to $130 (aka in-the-money)

Let’s see what happens if your expectation is right, and the stock climbs to $130 before expiration. If you exercise the option, your potential profit per share is the difference between the stock price and the strike price, minus the premium ($130 stock price - $120 strike price - $2 premium = $8 per share). If the contract is for 100 shares, you would earn $800. Alternatively, if you sell the option, your potential profit per share is the difference between the sale price and the premium you initially paid to enter the long call.

MEOW stays at $110 (aka out-of-the-money)

Now, let’s look at what happens if the stock doesn’t move as you expected. Instead of going up, the stock price stays at $110 until the option expires. Since that’s below the strike price of $120, the call should expire worthless, and you would lose the $2 premium per share, or $200 for the contract (the most you could lose on the trade in this example).

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 breakeven stock price at expiration?

You break even on your long call if the stock closes at the strike price of the option plus the premium you paid.

Going back to MEOW, the strike price ($120) plus the premium ($2) is $122. If the stock closes at this exact number on the option’s expiration date (and you exercise and sell shares, or sell your option), you neither profit nor lose money. If the stock rises above $122, you have the potential to profit. If it closes at or below the strike price the call should expire worthless, and you’ll lose the premium you paid upfront.

Monitoring

I bought a call option. What can I do next?

When you buy a call option, you have two choices before the expiration date: exercise it or sell it.

Exercising

You can exercise a call anytime before it expires to use your right to buy 100 shares of the underlying stock at the strike price. The seller of the call is obligated to sell the shares to you at this price. You might choose to exercise a call if the stock price goes higher than your breakeven price (the strike price plus the premium you paid). In this case, you buy the stock at a discount and can either sell the shares for a profit or hold them (and perhaps sell them later). Another reason you might exercise a call is if you can’t sell it for its intrinsic value (the difference between the stock price and the strike price). If that happens, exercising it and then selling shares might be the only way to fully realize your potential gains.

Selling to close

Instead of exercising a call, you could choose to sell it anytime before the expiration date to try to realize gains or prevent further losses. If the stock price rises above the breakeven point anytime before the expiration date, selling the call could allow you to realize a profit. That’s because the contract should be more valuable than when you bought it, since it gives the owner a right to buy shares for less than the prevailing market price.

If it doesn’t look like the stock price will rise higher than the break even point by the expiration date, you could potentially sell the call to get some of your premium back. (A buyer could be interested because there’s still a chance the stock price will increase in the time left.) You might also sell your call if you don’t have enough money to exercise it. In other words, you can’t afford to buy 100 shares of the underlying stock at the strike price.

Of course, you can also choose to do nothing and let the call option expire worthless. In this case, you’ll lose the premium you paid for it.

How might market movements affect my position?

Changes in the market can affect the value of your call option, since the price of a call is based on supply and demand for the contract.

Some options may not be as liquid as others. For instance, there might not be enough buyers for you to sell-to-close the position, and your contract’s price might be adversely affected. If your option isn’t very liquid, it can be hard to sell it for its intrinsic value or at all. The premium might not always correspond directly to price changes in the underlying stock.

Volatility, a measure of how much and how quickly a stock price changes, can also affect your position. If you buy a call, you generally benefit when volatility increases, because the value of your call should also increase, assuming all other factors are constant. Likewise, the option is likely to decrease in value when volatility declines.

Finally, the value of your call may decrease as the expiration date nears. That’s because it becomes less likely that the stock price will change significantly before the option expires (a factor known as time decay), and because it may be harder to find buyers for a less liquid option.

What are some potential edge cases?

When buying a call, there’s no risk of early assignment or dividend risk. You can learn more about potential edge cases regarding corporate actions here.

Selling a Covered Call

The Basics

What is selling a covered call?

Selling a covered call means opening a contract that gives you the obligation to sell shares of a stock you already own, at a certain price (the “strike price”) up until a set date (“expiration date”). In exchange, you receive an upfront amount (the “premium”) for selling this contract. A typical short call option entails the obligation to sell 100 shares of the underlying stock, and the call is “covered” because you already own the shares you might have to sell.

Because you have this obligation and hold the stock, in general it is beneficial for the stock price to stay relatively flat or increase moderately, and undesirable for the stock price to fall significantly. Your maximum potential profit is limited, but your potential losses are limited too.

Here’s some lingo to describe how your short covered call option is performing relative to the stock price:

  • In-the-money: The stock price is above the strike price
  • At-the-money: The stock price is at the strike price
  • Out-of-the-money: The stock price is below the strike price

Please note: Robinhood does not allow uncovered or naked positions, as selling a call on stock you don’t own may involve the risk of unlimited losses.

When might I use this strategy?

You might consider selling a covered call if you think a stock price will stay relatively stable or rise somewhat in the near future (i.e., you have a neutral-to-bullish outlook). You can only do this on Robinhood if you own enough shares in the underlying stock to cover the short call if it’s assigned.

One reason to use this strategy is to earn additional income on stocks you own. If you’re planning to hold the underlying shares anyway, selling covered calls can be a way to help generate income from the premiums you receive (aka to “monetize” your holdings). But there’s a tradeoff — You give up the potential to profit if the stock price soars above the strike price. When this happens, the call has the potential to be assigned. (Note: Calls are usually assigned at expiration, but can happen at any time beforehand.) Remember, you’re obligated to sell your shares at the strike price if the buyer chooses to exercise the option.

Selling a covered call can also be a way to help protect yourself if the stock price declines. The premium you received for the call can slightly offset your losses. Still, selling a call can’t protect you from losing money if the stock price falls below the breakeven price.

What are factors to consider?

Here are a few key factors:

Expiration date: Selling calls with a closer expiration date means you’re reducing the time frame in which you’re capping your potential gains from the stock you own. If they expire worthless, you can sell calls more often. Selling calls that expire later means you cap your potential profit for longer and can’t write new calls as often. However, calls with a later expiration date usually generate higher premiums upfront, assuming all other factors are constant.

Strike price: This is the price at which you’re required to sell your shares if the call is assigned. Assuming all other factors are constant, calls with lower strike prices are more likely to be assigned and typically sell for a higher premium. Calls with a higher strike price are less likely to be assigned and usually have a lower premium. A higher strike price gives you more leeway to benefit from a rise in the stock price, since the ceiling on your potential gains is higher.

Contract: Each option typically represents 100 shares. If you sell more covered calls, the total premium you receive is higher. But you also need to own more shares of stock to cover the calls — and if the price of the stock you own increases, there’s potential for you to miss out on even greater gains. However, selling covered calls also offers some downside protection, since the premium you receive can partially offset a decrease in the stock price.

Premium: This is the money you receive upfront for selling the call. The higher the premium, the more the stock can drop before you break even on the overall position. But, a call with a higher premium is also more likely to be assigned, which can mean giving up more potential gains if a stock price rises.

Calculations

Can I see an example?

Let’s say you buy or already own 100 shares of the fictional MEOW company at a price of $110, and you expect the stock will stay relatively flat or increase moderately in the near future. You could consider selling a call option for MEOW at a strike price of $125, for which you’d receive a $1 premium per share ($100 total).

Maximum Gain or Loss

Your maximum potential gain is limited to the difference between the strike price and the stock price, plus the premium you received. You can realize this gain if the call is assigned and you sell the stock, which typically happens when the stock price is higher than the strike price at expiration.

Meanwhile, in theory, you’d experience your maximum potential loss if the stock price fell all the way to $0. Like any stock owner, you risk losing the entire value of the shares—except when you sell a covered call, you would keep the total premium you received upfront.

MEOW rises to $130 (aka in-the-money)

Let’s assume your expectation is right, and MEOW’s stock closes at $130 on the short call’s expiration date. Since this is above the strike price of $125, the call is assigned, and you are obligated to sell your shares for $125 each. Your gain per share is $15, or the strike price ($125) minus the price you paid for the stock ($110). Multiplying by the number of shares you own (100), this comes out to $1,500. You also received a $1 premium per share, or $100 total, for selling the call. So, your total gain is $1,600 (that is, $1,500 plus $100). Keep in mind, this is your maximum potential gain in this example. Even though the stock price rose to $130, the strike price ($125) of the option limits your potential gains. By comparison, if you had only bought and held 100 shares, the value of your stock would’ve increased by $2,000 — that is, ($130 - $110) * 100 shares.

MEOW rises to $125 (aka at-the-money)

Let’s say MEOW’s stock price closes at $125 on the call’s expiration date. Since this is at the strike price, the call should expire worthless. Once again, your gain per share is the current stock price ($125) minus the price you paid for the stock ($110), which equals $15. If the contract is for 100 shares, you would gain $1,500 from owning the stock. To calculate your total gain though, add the $1 premium you received per share for selling a call option ($100 total). In this instance, your total profit for the strategy is $1,500 plus $100, or $1,600. If you had only bought and held 100 shares, the value of your stock would’ve increased by $1,500.

MEOW falls to $100 (aka out-of-the-money)

Now, let’s look at what happens if MEOW’s stock price doesn’t move as you expected, and instead closes at $100 on the call’s expiration date. To calculate the decline in the value of your stock, take the current stock price ($100) and subtract the price you paid for it ($110). Multiply this by the 100 shares you own, and this comes to -$1,000. The premium you received upfront ($100) helps offset this decline, meaning your net loss is $900. If you had only bought and held the shares, your net loss would’ve been $1,000.

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 expiration?

You break even on your covered call if, on the expiration date, the stock closes at the price you originally paid for the stock minus the premium you received per share for selling the call.

Going back to MEOW, you paid $110 per share to buy the stock. Subtracting the premium you received per share equals $109 ($110 - $1). If the stock closes at this price on the expiration date, the option should expire worthless, and you should neither gain nor lose money. If the stock falls below $109, you should experience a loss.

Monitoring

I sold a covered call option. What can happen next?

When you sell a covered call option, there are several possibilities for what could happen next: Buying to close your position, assignment, or expiration.

Buying to close

By selling a call option against your shares, you create an “open” position. You can later “close” it by buying back the option, anytime before it expires, which can allow you to keep your stock and avoid getting assigned. Holding the stock also gives you the potential to sell additional covered calls once the collateral (your shares) is freed up.

Assignment

Alternatively, the call you sold could get assigned (meaning the buyer decides to exercise it). Remember, since you’re the seller, you can’t exercise it — Only the buyer can do this. If you’re assigned, then you must sell the stock at the strike price. Often, this happens if the stock price is above the strike price at expiration. But a call can be assigned early, too. This is especially likely to happen before ex-dividend dates, the last day by which you can buy a stock in order to be eligible to receive dividends on the shares. If early assignment happens before the ex-dividend date, you will not be entitled to the dividend.

Call Expiration

If the stock price is below the strike price at expiration, your call will likely expire worthless. This would free up your shares, allowing you to potentially: sell another call, keep holding the stock, or sell your shares.

How might market movements affect my position?

Changes in the market can affect the value of your covered call and your ability to close it. First, you can benefit from an increase in the price of the underlying stock, since you own those shares. However, this is only true up to the strike price, which puts a limit on your potential gains. Also, as the stock price rises, the value of your short call position declines.

Volatility, a measure of how much and how quickly a stock price changes, can also affect your position. If you sell a covered call, you generally benefit when volatility declines, because the value of the call you sold should also decline, assuming all other factors are constant. On the other hand, an increase in volatility in the underlying stock can make it more expensive to close your position.

If the stock price and volatility stay pretty flat, the value of your covered call position tends to increase as time passes. As the expiration date nears, the price of the short call falls, making it less expensive to potentially close the position.

What are some potential edge cases?

For selling a covered call, two of the more common edge cases are: 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 is assigned on the short call option, the trader will be obligated to sell their shares of stock at the covered call’s strike price. In this case, a trader will no longer own the shares associated with the covered call option, and see an increase in buying power in their Robinhood account. 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, not receive the dividend). 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.

Buying a Put

The Basics

What does it mean to buy a put?

Buying a put option (aka a “long put”) means opening a contract that gives you the right, but not the obligation, to sell shares of a stock at a certain price (the “strike price”) up until a set date (“expiration date”). In exchange for this right (known as the ability to “exercise” the option), you pay an upfront cost (the “premium”). A typical long put option offers the right to sell 100 shares of the underlying stock. Keep in mind, Robinhood only allows you to exercise a put when you already own the underlying shares you’re selling.

Because you have the right to sell shares, it’s generally beneficial for the price of the underlying stock to fall in value (i.e., you have a bearish outlook). Your potential gain is significant but limited, and your potential losses are limited, too.

Here’s some lingo to describe how your put option is performing relative to the stock price:

  • In-the-money: The stock price is below the strike price
  • At-the-money: The stock price is at the strike price
  • Out-of-the-money: The stock price is above the strike price

When might I use this strategy?

You might consider buying a put if you expect a stock price to decrease (i.e., you have a bearish outlook). When you buy a put, you expect that the value of the put will rise as the price of the underlying stock drops (though not necessarily dollar-for-dollar), before the expiration date. In theory, the maximum potential gain is equal to the strike price of the put minus the premium per share, multiplied by 100. You should realize the maximum gain if the stock price falls all the way to $0.

On the other hand, your maximum potential loss is limited to the total premium (aka premium per share * 100) you paid for the long put. You will lose this amount if the put expires worthless, which should happen if the stock price doesn’t drop below the strike price before expiration.

What are factors to consider?

Here are a few key factors:

  • Expiration date: If you want to either sell or exercise the option, you must do so by this date. If you don’t, the option expires, and you no longer have the right to sell the underlying stock at the strike price. The further away the expiration date, the lower the risk of losses, assuming all other factors are constant. That’s because there’s more time for the stock price to potentially fall. For the same reason, the premium is likely to be higher for options with later expiration dates.

  • Strike price: This is the price at which you can sell the underlying stock if you choose to exercise the option, regardless of the price at which the stock is trading (“prevailing market price”). When buying a put, lower strike prices typically come with a higher risk of losses, assuming all other factors are constant. That’s because the stock would have to fall more for the option position to become profitable.

  • Premium: This is the price you pay to buy the put. The more you pay for the put, the more you could potentially lose.

  • Contract: Each option typically represents 100 shares. The more contracts you buy the greater your exposure to potential gains and losses on the position.

Calculations

Can I see an example?

Let’s say you think the stock price of the fictional MEOW company, which is trading at $110 a share, will fall soon. You pay a $1 premium ($100 total) to buy a put option, giving you the right to sell 100 MEOW shares at a strike price of $95.

Maximum Gain or Loss

You’d reach your maximum potential gain if the price of the underlying stock fell to $0, which is theoretically possible but highly unlikely. In this case, your maximum potential gain equals the strike price of the put minus the premium you paid ($95 - $1 = $94). If the options contract represents 100 shares, the most you could gain is $9,400. Your maximum potential loss is limited to the total premium ($100). In general, your total premium will depend on factors such as the strike price of the contract, the expiration date, and the number of contracts purchased.

MEOW falls to $90 (aka in-the-money)

Let’s see what happens if your expectation is right, and the stock falls to $90 on the expiration date. If you sell the option, your potential gain per share is the difference between the strike price and the stock price, minus the premium ($95 strike price - $90 stock price - $1 premium = $4). If the contract represents 100 shares, your total gain is $400.

MEOW rises to $120 (aka out-of-the-money)

Let’s see what happens if the stock doesn’t move as you expected. Instead of going down, the stock price rises to $120 by the time the option expires. Since that’s above the strike price of $95, the put should expire worthless, and you would lose the $1 premium, or $100 in total. Again, this is the maximum you could lose in this example. You’ll experience this maximum loss anytime the stock price is at or above 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 breakeven point at expiration?

You break even on your long put if the stock closes at the strike price of the option minus the total premium you paid.

Going back to MEOW, the strike price minus the premium per share ($95 - $1) equals $94. If the stock closes at the breakeven point on the expiration date, you should neither gain nor lose money. If the stock drops below $94, you have the potential to profit. If it closes at or above $95, the put should expire worthless, and you’ll lose the premium you paid upfront.

Monitoring

I bought a put option. What can I do next?

When you buy a put option, you have two choices before the expiration date: Exercise it or sell it.

Exercising

As long as you already own enough shares of the stock to exercise your put, you can exercise your right to sell the shares at the strike price anytime before the option expires. The seller of the put is obligated to buy the shares from you at this price. You might choose to exercise your put option if the stock price drops below your breakeven point (the strike price minus the premium per share). In this case, you’d sell your shares for more than the prevailing market price. Another reason you might exercise a put is if you can’t sell it for its intrinsic value (the difference between the stock price and the strike price). If that happens, exercising it might be the only way to fully realize your potential gains.

Please note: Robinhood only allows you to exercise a put if you already own the shares you’ll be selling.

Selling to close

Instead of exercising a put, you may sell-to-close the position anytime before the expiration date to try to realize gains or prevent further losses. If the stock price falls below the breakeven point anytime before expiration, closing the position could allow you to realize a gain. That’s because the contract should be more valuable than when you bought it, since it gives the owner the right to sell shares for more than the prevailing market price.

If it doesn’t look like the stock price will drop below the breakeven point by the expiration date, you could potentially close your position to recoup some of your premium. (A buyer could be interested because there’s still a chance that the stock price will decrease in the time left.) You might also sell-to-close if you don’t own enough shares to exercise the contract.

Of course, you can also choose to do nothing and let the put option expire worthless. In this case, you’ll experience a loss equal to the total premium you paid upfront.

How might market movements affect my position?

Changes in the market can affect the value of your put option, since the price of a put is based on supply and demand for the contract.

Some options may not be as liquid as others. For instance, there might not be enough buyers for you to sell-to-close the position, and your contract’s price might be adversely affected. If your option isn’t very liquid, it can be hard to sell it for its intrinsic value or at all. The premium might not always correspond directly to price changes in the underlying stock.

Volatility, a measure of how much and how quickly a stock price changes, can also affect your position. If you buy a put, you generally benefit when volatility increases, because the value of your put should also increase, assuming all other factors are constant. Likewise, the option is likely to decrease in value when volatility declines.

Finally, the value of your put may decrease as the expiration date nears. That’s because it becomes less likely that the stock price will change significantly by the time the option expires (a factor known as time decay), and because it may be harder to find buyers for a less liquid option.

What are some potential edge cases?

When buying a put, there’s no risk of early assignment or dividend risk. You can learn more about potential edge cases regarding corporate actions here.

Selling a Cash Covered Put

The Basics

What is selling a cash covered put?

Selling a cash-covered put option (aka writing a cash-secured short put) means opening a contract where you have the obligation to buy shares of a stock at a certain price (the “strike price”) up until a set date (“expiration date”), and you already have the cash to meet your obligation (aka it’s “cash-covered”). You receive an upfront amount (the “premium”) in exchange for selling this contract. A typical short put option entails the obligation to buy 100 shares of the underlying stock.

Because you have this obligation, in general it’s beneficial for the stock price to stay relatively flat or increase in the future, and it’s undesirable for the stock price to fall. Your maximum potential profit is limited, while your maximum potential loss could be substantial.

Here’s some lingo to describe how your short covered put option is performing relative to the stock price:

  • In-the-money: The stock price is below the strike price
  • At-the-money: The stock price is at the strike price
  • Out-of-the-money: The stock price is above the strike price

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

When might I use this strategy?

You might consider selling a cash-covered put if you think a stock price will stay relatively flat or rise in the future (i.e., you have a neutral-to-bullish outlook). You can do this on Robinhood only if you hold enough cash to cover your short put.

There are typically two main reasons to use this strategy: To potentially buy a stock you would like to own for less than its prevailing market price, or to earn additional income through the premium you receive by selling the contract (aka “monetizing” uninvested cash). If the stock price ends up staying at or above the strike price before expiration, the option should expire worthless and you get to keep the premium you received for the put. If the stock price closes below the strike price on the expiration date, the put will likely be assigned, in which case you would buy shares at the strike price and keep the premium you received for the put. In that situation, you’re paying above market price for the shares, but you’d be generally paying less than you would have if you bought shares at the time that you sold the put.

Keep in mind that your losses from being assigned can be significant, if the strike price is much higher than the prevailing market price.

What are factors to consider?

Here are a few key factors:

  • Expiration date: Assuming all other factors are constant, selling a put with a nearer expiration date will typically have a lower premium, but it also reduces the time frame in which the stock could fall below the breakeven point. If the put expires worthless, you can potentially write new puts more often. Selling puts that expire later typically means you can receive a higher premium, but you won’t be able to write new puts as often. Even though you receive more upfront, there’s also more time for the stock to move below the breakeven point.

  • Strike price: This is the price at which you’re required to buy the shares if the put is assigned. Puts with a lower strike price are less likely to be assigned and usually earn a lower premium, while puts with a higher strike price generally have a greater chance of being assigned and usually earn a higher premium.

  • Premium: This is the money you receive upfront for selling the put. Assuming all other factors are constant, the higher the premium you receive, the more likely the put will be assigned, and the more likely it is that you’ll need to buy the underlying shares at the strike price.

  • Contract: Each option typically represents 100 shares. If you sell more cash-covered puts, the total premium you receive is higher. But you also need more cash on hand in case they’re assigned. Selling fewer puts means you get less money in premiums. However, you don’t need as much cash to cover the contracts, and you take on less risk.

Calculations

Can I see an example?

Let’s say you expect stock in the fictional PURR company, which is trading at a price of $50 a share, to stay relatively flat or increase in the near future. So, you decide to sell a put option for PURR shares at a strike price of $45, receiving a $2 premium. You have enough cash in your account to buy 100 PURR shares at this price ($45 * 100 = $4,500 of uninvested cash), so your put is covered.

Maximum Gain and Loss

Your maximum potential gain is the premium you received. In this case, that’s $2 per share, or $200 total. This should be realized if the stock closes at or above the strike price on the expiration date, and the option expires worthless.

In the worst-case scenario, the stock price could fall all the way to $0. If that happens with PURR, your loss would be $43 per share ($0 - $45 + $2). That’s a $4,300 loss for a contract that represents 100 shares.

PURR rises to $55 (aka out-of-the-money)

Let’s say your expectation is met, and PURR’s stock price climbs to $55 at expiration. Since this is above the strike price, the put shouldn’t be assigned and should expire worthless, allowing you to gain $200 in total premium for 100 shares. This is the maximum potential gain on this trade, even if the stock price increases further.

PURR falls to $35 (aka in-the-money)

Instead, let’s assume PURR’s stock price falls to $35 per share at expiration. The option should be assigned, obligating you to buy PURR stock for $45, which is $10 above its market price. Assuming you immediately sell the shares at $35, the premium you received upfront partially offsets your loss of $10 per share. To calculate your loss per share, subtract the strike price from the price of the stock at expiration, and add the premium you received. In this example, ($35 - $45 + $2 = -$8 per share). So for a contract of 100 shares, you would lose $800.

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 breakeven point at expiration?

You break even on your cash-covered put, if the stock closes at the strike price of the option minus the premium you received.

Going back to PURR, the breakeven point is ($45 strike price - $2 premium = $43). If the stock closes at this breakeven point on the expiration date, you should neither gain nor lose money. If the stock price falls below $43, you’ll likely experience a loss.

Monitoring

I sold a cash covered put. What can I do next?

When you sell a cash-covered put, there are several potential outcomes up until the expiration date: Buying to close your position, assignment, or expiration.

Buying to Close

By selling a cash covered put option, you “open” a position. You can “close” it by buying back the option. You can choose to do this at any time until it expires, in order to avoid getting assigned. You would then have the possibility of writing another cash covered put, depending on the amount of cash you have available to be held as collateral.

Assignment

Alternatively, the put you sold could get assigned, meaning the buyer decides to exercise their right to sell the shares at the strike price. Remember, since you’re the seller of the put, you can’t exercise it — Only the buyer can do this. If the buyer decides to exercise their put, then you must buy the stock at the strike price. Often, this happens if the stock price is below the strike price at expiration. A put could also be assigned early, but because you sold a cash-covered put, you have already accepted the obligation to buy shares at the strike price and have the cash collateral to do so. After buying the shares, you can sell the shares if you’d like to.

Put Expiration

If the put you sold expires worthless, you keep the premium and can do a few things: Sell another put, buy shares of stock, invest the cash somewhere else, or simply leave it uninvested.

How might market movements affect my position?

Changes in the market can affect the value of your put option and your ability to close it. First, some options may not be as liquid as others. This means there might not be enough sellers to allow you to buy-to-close your position, and your contract’s price might be adversely affected. If your option isn’t very liquid, it can be hard to buy it back for its intrinsic value.

Volatility, a measure of how much and how quickly a stock price changes, can also affect your position. If you sell a covered put, you generally benefit when volatility declines, since the value of the option you sold should also decrease, assuming other factors stay constant. On the other hand, an increase in volatility in the underlying stock can make it more expensive to buy-to-close the position.

If the stock price and volatility stay relatively flat, the value of your cash-covered put option tends to decrease as time passes. As the expiration date nears, it becomes less likely that the stock will drop below the strike price, and more likely that the option will expire worthless, allowing you to keep the premium. Hence, it is generally beneficial for the short position when the option loses value as it approaches expiration.

What are some potential edge cases?

For selling a cash covered put, early assignment risk is one of the more common edge cases.

Early assignment risk

An early assignment occurs when the contract a trader sold is exercised before its expiration date. If a trader is assigned on the short put option, the trader will be obligated to buy the shares of stock at the covered put’s strike price. Learn more about early assignments here.

You can learn more about potential edge cases regarding corporate actions here.

Straddles and Strangles

The Basics

What are straddles and strangles?

Using long straddles and strangles means buying a call option and a put option on the same underlying stock with the same expiration date. Buying a call means entering a contract that gives you the right, but not the obligation, to buy shares of a stock at a certain price (the “strike price”) up until a set date (“expiration date”). Meanwhile, buying a put gives you the right, but not the obligation, to sell shares of a stock at the strike price by the expiration date. In exchange for these rights (known as the ability to “exercise” the options) you pay an upfront cost (the “premium”) for these contracts.

A straddle is composed of a long call and a long put at the same strike price, meaning you have the right to buy and sell shares at the same strike price.

A strangle is also composed of long call and put options, but the call option has a higher strike price than the put option. A typical option allows you to buy or sell 100 shares of the underlying stock at the exercise price.

Here’s some lingo to describe how your straddles and strangles are performing relative to the stock price. In straddles and strangles, when one of the two options is in-the-money, the other is always out-of-the-money:

  • In-the-money: For the call, the stock price is above the strike price, while for the put, the stock price is below the strike price.
  • At-the-money: The stock price is at the strike price
  • Out-of-the-money: For the call, the stock price is below the strike price, while for the put, the stock price is above the strike price.

Please note: Robinhood does not allow short straddles or short strangles, because these strategies involve selling uncovered call and put options (aka naked positions). In an uncovered short position, the seller doesn’t have the required collateral, which means their position involves the risk of unlimited losses.

When might I use this strategy?

You might consider opening a straddle or strangle if you expect big changes in a stock price before a certain date, but you’re not sure in which direction. For example, perhaps you believe a major legal or regulatory decision is around the corner. If your expectation of higher volatility pans out, you could realize a gain regardless of whether the stock price rises or falls (i.e., your outlook can be both bullish and bearish).

Your maximum potential gain is unlimited, since the stock price could theoretically rise to any number. On the other hand, the stock price could drop to $0, which could also yield significant gains for the straddle or strangle holder. Both of these scenarios are highly unlikely though. Your maximum potential loss is the total premium you pay upfront for the options. Strangles are usually less expensive to open than straddles, but strangles require the stock to move more for you to realize a gain.

Why would you open a straddle or strangle instead of buying only a call or a put?

It might make sense to buy only a call if you think the stock price will increase (i.e., you have a bullish outlook) or buy only a put if you think it will fall (i.e., you have a bearish outlook). If you think the price will move sharply, but you aren’t sure of which direction, a straddle or strangle can help you gain exposure either way. However, in exchange for this flexibility, you need to pay two premiums because you’re buying both a call and a put.

What are factors to consider?

Here are a few key factors:

  • Expiration date: If you want to either sell or exercise one of the options, you must do it by this date. If you don’t, the option expires, and you no longer have the right to buy or sell the underlying stock at the strike price. The further away the expiration date, the less risk of losses the options typically have, assuming all other factors are constant. That’s because there’s more time for the stock price to make a big move up or down. For the same reason, the premium is likely to be higher for options with later expiration dates.
  • Strike price: This is the price you pay for the underlying stock if you choose to exercise the call option, or the price you sell it for if you exercise the put option, regardless of the price at which the stock is trading (the “prevailing market price”). The further the strike prices are from the current stock price, the lower the premiums will probably be, assuming all other factors are constant. That’s because the stock would have to rise or fall more sharply for you to realize a gain.
  • Premium: This is the price you pay to buy the call and put. Typically, premiums for straddles and strangles are higher (i.e., the options cost more) when implied volatility is higher. Implied volatility is a measure of how much the stock market is pricing in an expected stock price movement up until the expiration date.
  • Contract: Each option typically represents 100 shares. The more contracts you buy the greater your exposure to potential gains and losses on the position.
Calculations

Can I see an example?

Let’s say you think the stock price of the fictional HISS company, which is trading at $100, will move sharply soon — but you don’t know in which direction. You decide to open a strangle: You pay a $2 premium per share to buy one call option giving you the right to purchase HISS shares at a strike price of $110. You also pay a $3 premium per share to buy one put option giving you the right to sell HISS shares at a strike price of $90. Notice that the long call has a higher strike price than the long put.

Maximum Gain or Loss

If the stock price increases, your maximum potential gain is theoretically infinite, since there is no ceiling on how much the stock price can rise. You could also profit if the stock price decreases, but there is a limit on how low a stock price can drop ($0). On the other hand, the maximum potential loss is limited to the two premiums you paid upfront ($2 + $3 = $5 per share). Assuming the options represent 100 shares, you could lose up to $500 total in this example.

HISS falls to $80 (aka in-the-money put, out-of-the-money call)

Let’s see what happens if the stock price falls to $80 at expiration. If you sell the put option, your potential gain per share is the difference between the put’s strike price and the stock price, minus the premium ($90 strike price - $80 stock price - $5 premium = $5 per share). If the contract is for 100 shares, you’d gain $500. Your call option should expire worthless since it’s out-of-the-money.

HISS rises to $120 (aka in-the-money call, out-of-the-money put)

Instead, say the stock price rises to $120. If you sell the call option, your potential gain per share is the difference between the stock price and the call’s strike price, minus the premium ($120 stock price - $110 strike price - $5 premium = $5 per share). If the contract is for 100 shares, you would again gain $500. Your put option should expire worthless since it’s out-of-the-money.

HISS stays at $100 (out-of-the-money call and put)

Let’s consider what happens if things don’t go as you expected, and the stock price stays at $100. Both of your options should expire worthless because they are both out-of-the-money. Your loss per share is the total premium you paid for both options ($5), or $500 in total. This is the most you could lose on the trade in this example.

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 breakeven point at expiration?

There are two breakeven points on a straddle or a strangle: You break even if the stock closes either above the call strike price (“higher breakeven point”) or below the put strike price (“lower breakeven point”) by the amount of total premium you paid upfront. (Remember, the options have the same strike price in a straddle.)

Going back to HISS strangle, the strike price of the long put ($90) minus the premium per share ($5) is $85. If the stock closes at the lower breakeven point on the expiration date, you neither gain nor lose money. You can sell or exercise the long put, while the long call should expire worthless. If the stock closes below $85, you could realize a gain.

To calculate the second breakeven point, add the strike price of the long call to the premium per share ($110 + $5 = $115). If the stock closes at the higher breakeven point on the expiration date, you neither gain nor lose money. You can sell or exercise the long call, while the long put should expire worthless. If the stock closes above $115, you could realize a gain.

If the stock stays between $85 and $115 until expiration, you can potentially lose money. Again, in using this strategy, you’re expecting a dramatic move in the stock price.

Monitoring

I bought a strangle or a straddle. What can I do next?

When you open a straddle or strangle, you have two choices before the expiration date: Exercise one of your options or sell them.

Exercising

You can exercise a call or put anytime before it expires to use your right to buy or sell 100 shares of the underlying stock at the strike price. You might choose to exercise a call if the stock price exceeds your higher breakeven point, or you might exercise a put if the stock price goes below your lower breakeven point. Exercising an option might make sense if you have the necessary collateral (either cash or shares) to buy or sell the stocks at the strike price. Another reason you might exercise a call or put is if you can’t sell it for its intrinsic value (the difference between the stock price and the strike price). If that happens, exercising it and then selling shares might be the only way to fully realize your potential gains.

Selling

Instead of exercising your options, you could choose to sell them anytime before the expiration date to try to realize gains or prevent further losses. If the stock price goes beyond one of the breakeven points anytime before expiration, selling that option could allow you to realize a gain. That’s because the contract should now be more valuable than when you bought it, since it gives the owner the right to buy shares for less (call option), or sell them for more (put option), than the prevailing market price.

If it doesn’t look like the stock price will move past one of the breakeven points by the expiration date, you can sell the options to try to get some of your premium back. (A buyer could be interested because there’s still a chance the stock price will move dramatically in the time left.) You might also sell your options if you don’t have enough assets to exercise them. In other words, you can’t afford to buy 100 shares of the underlying stock at the strike price, or you don’t have the shares available to sell.

Of course, you can also choose to do nothing and let the options expire worthless.In this case, you’ll experience a loss equal to the total premium you paid upfront.

How might market movements affect my position?

Changes in the market can affect the value of your options and your ability to sell them. First, some options aren’t as liquid as others. This means there may not be enough buyers or sellers to allow you to buy or sell without adversely affecting your contracts’ price. If your option isn’t very liquid, it can be hard to sell it for its intrinsic value.

Also, the price of an option (aka its premium) is based on the supply and demand for the contract. That means the premium might not always correspond to price changes in the underlying stock.

Volatility, a measure of how much and how quickly a stock price changes, can also affect your position. If you buy a straddle or strangle, you generally benefit when volatility increases, because the value of your call and put should also increase, assuming all other factors are constant. Likewise, the option is likely to decrease in value when volatility declines.

If the stock price stays relatively flat, the premiums on your options may decrease as the expiration date nears. That’s because it becomes less likely that the stock price will change significantly before the options expire (a factor known as time decay).

What are some potential edge cases?

When buying a strangle or straddle, there’s no risk of early assignment or dividend risk. You can learn more about potential edge cases regarding corporate actions here.

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. 1312477
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