Deep Dive · extends Ch. 6: Options & Derivatives
Options Strategies: Combining Positions
Spreads, straddles, and covered calls — how real positions are built from more than one option at once
Chapter 6 covered a single call or put in isolation. In practice, options are very often traded in combination — multiple positions structured together to express a specific view or manage risk in a way a single option can't. This deep dive covers the handful of combinations that come up constantly.
Vertical spreads — capping both cost and payoff
A bull call spread: buy a call at a lower strike, simultaneously sell a call at a higher strike (same expiration). Selling the higher-strike call reduces your net cost (you collect its premium, partially offsetting what you paid for the lower-strike call) — but it also caps your maximum profit at the difference between the two strikes. This is a direct, deliberate trade-off: give up unlimited upside in exchange for a cheaper, defined-risk position, useful when you have a moderately bullish view rather than an unlimited one. A bear put spread is the mirror image for a moderately bearish view.
Straddles and strangles — betting on volatility itself, not direction
A long straddle: buy a call and a put at the same strike and expiration simultaneously. This position profits if the underlying makes a large move in either direction — you don't need to be right about direction, just about the magnitude of the move. This is a direct, tradeable expression of Chapter 6's "an option's price is fundamentally a bet on volatility" idea — a straddle is a pure volatility bet with the direction question stripped out entirely. A strangle is the same idea using out-of-the-money calls and puts (different strikes instead of the same one) — cheaper to put on than a straddle, but requiring an even larger move to profit, since both options start further from the money.
Covered calls — generating income against a stock you already own
If you already own 100 shares of a stock, selling a call against them (a covered call) collects the option premium as income, in exchange for capping your upside if the stock rallies past the strike (since you're now obligated to sell your shares at that strike if the buyer exercises). This is a genuinely common real-world income strategy, not just a textbook example — the trade-off is straightforward: extra income now, in exchange for giving up participation in a large rally.
Protective puts — insurance on a position you own
Buying a put against stock you already own caps your downside (you can always sell at the put's strike, no matter how far the stock falls) in exchange for paying the put's premium — functionally, portfolio insurance. The collar strategy combines this with a covered call: sell a call to help pay for the protective put, capping both your upside and downside in a defined range, often at a low or even zero net cost.
The actual skill being built here
Every one of these strategies is just the single-option mechanics from Chapter 6, combined deliberately to express a more specific view than "up," "down," or "volatile" alone can capture — a moderate view, a pure volatility view, an income view, or a risk-limiting view on an existing position. Recognizing which combination fits a given market opinion, and being able to draw its payoff diagram from first principles rather than memorizing it, is the real skill an options desk is testing for.
Check your understanding
1. What view does a long straddle (buying a call and a put at the same strike) express?
2. What's the trade-off of selling a covered call against stock you already own?
3. In a bull call spread, why does selling the higher-strike call reduce your net cost but also cap your maximum profit?