What is an options strategy?

Every options strategy is built from four basic positions: buying a call, buying a put, selling a call and selling a put. Add shares of the underlying stock and you have every piece you need. A single-leg strategy uses one option. A multi-leg strategy combines two or more options on the same underlying, usually opened together as one order.

Strategies are compared by their payoff at expiration: profit or loss against the stock price on the last day. Before then the position also reacts to time decay and implied volatility, but the expiration payoff shows where it makes money, where it loses and whether the loss has a floor. One standard US stock or ETF option covers 100 shares, and premiums are quoted per share, so a $2.00 premium is $200 per contract. If calls and puts are new to you, start with options trading for beginners and call vs put.

Turn your phone sideways to read the drawing. Tap to close.

A hand-drawn payoff chart for buying a call, the simplest single-leg strategy: a flat line at the premium paid up to the strike, then a rising line that crosses zero at the breakeven.

Options strategies by market view: bullish, bearish, neutral or a big move

Start with your view of the underlying over the life of the trade. Each strategy below has its own guide: the covered call and the cash-secured put are the two income strategies on stock; vertical spreads cover the bull call, bear put, bull put and bear call spreads; the iron condor is the range strategy; and the straddle and strangle are the big-move strategies.

The map at the top of this page sorts them into four outlooks, the columns, and two rows. Strategies in the top row buy options: you pay premium and need the stock to move, soon enough to beat time decay. Strategies in the bottom row sell options: you collect premium and want the stock to stay calm while time decay works for you. By outlook:

  • Bullish, you expect a rise: buy a call, or a bull call spread to cut the cost in exchange for a capped gain. A cash-secured put or a covered call suits a milder view, flat to slightly up.
  • Bearish, you expect a fall: buy a put, or a bear put spread. A bear call spread collects premium when you expect the stock to stay below a level.
  • Neutral, you expect a range: an iron condor collects premium and keeps the most if the stock finishes between its two short strikes. A covered call also benefits from a quiet stock you already own.
  • A big move either way, you expect a jump but not its direction: buy a straddle or a strangle, which needs the stock to move by more than the combined premium.

Defined risk vs undefined risk: what can you lose?

The second way to sort strategies is by maximum loss, and it matters more than the maximum gain. A defined-risk strategy has a known worst case the moment you open it. Other strategies carry a large loss that ends only if the stock goes to zero, and one, the naked call, has no ceiling at all.

Brokers reflect this in options approval levels. Each broker sets its own tiers, but covered calls and cash-secured puts usually sit at the lowest levels, buying calls and puts close to them, spreads higher, and uncovered selling at the top, with margin requirements on top. A low approval level means the obligation is covered, not that the risk is small. The maximum loss of each strategy, per contract:

  • Long call or long put: the premium paid.
  • Debit spread (bull call or bear put): the net premium paid.
  • Credit spread (bull put or bear call) and iron condor: the width between the strikes minus the premium collected, times 100.
  • Covered call: the stock price paid minus the premium, times 100, if the stock goes to zero.
  • Cash-secured put: the strike minus the premium, times 100, if the stock goes to zero.
  • Naked call, sold without owning the shares: theoretically unlimited, because a stock price has no ceiling.

Debit vs credit strategies, and income vs directional trades

A debit strategy costs money to open: you pay premium, as when you buy a call or open a bull call spread. A credit strategy pays you to open: you collect premium, as when you sell a covered call, a cash-secured put, a credit spread or an iron condor. The premium collected is the most a credit strategy can make.

Time decay splits them. An option’s time value shrinks as expiration approaches, faster in the final weeks, as the drawing shows. That decay works against debit strategies and for credit strategies. The trade-off is in the payoff: debit strategies risk a capped amount for a chance to gain more than they cost, while credit strategies collect a capped gain in exchange for a larger possible loss. The market prices both sides, so neither is free money. Our options Greeks guide explains theta, the measure of that decay.

Traders also speak of income and directional strategies. Income strategies, such as covered calls and cash-secured puts, sell premium again and again on stocks you own or would buy; directional ones, such as long options and debit spreads, are bets on a move. The word income can mislead: the stock risk is as real as the premium, and one sharp drop can outweigh many months of it.

Leg
One option inside a multi-leg strategy. A vertical spread has two legs, an iron condor four.
Debit strategy
A strategy that costs a net premium to open, such as a long call or a bull call spread. Its maximum loss is usually the premium paid.
Credit strategy
A strategy that collects a net premium when opened, such as a covered call, a cash-secured put or an iron condor. The premium is its maximum gain.
Defined risk
A position whose worst-case loss is known and capped when it is opened, such as a long option or a vertical spread.

Turn your phone sideways to read the drawing. Tap to close.

A hand-drawn time-decay curve: an option’s time value shrinks slowly with weeks to go, then drops fast in the final days before expiration. Option buyers pay this decay; option sellers collect it.

How to choose an options strategy: outlook, implied volatility, time and max loss

No strategy is best in general; each fits a set of conditions. Run through these five questions before you pick one:

  1. Outlook: up, down, sideways or a big move, and by how much? A strategy that needs a 10% move is the wrong tool for a 2% view.
  2. Implied volatility: is IV high or low compared with the stock’s own history? High IV makes options expensive, which pays sellers more and costs buyers more; low IV does the reverse. High IV is not a reason to sell on its own, because the market is pricing a bigger move, often for earnings. Our implied volatility guide shows how to compare IV with its past.
  3. Time: how long should the move take? Choose an expiration that outlasts the plan, as explained in how to choose a strike price, and note any earnings or ex-dividend date before it. The last day itself is covered in options expiration.
  4. Maximum loss: write down the worst case in dollars before you enter, and size so that it is a loss you can afford. With defined-risk strategies it is fixed when you open; with covered calls and cash-secured puts it is the stock falling a long way.
  5. Capital and approval: a covered call needs 100 shares per contract, a cash-secured put needs the strike times 100 in cash, and spreads need spread approval. Choose what your account and approval level can actually support.

Four ways to trade the same bullish view (hypothetical example)

All numbers here are hypothetical, from a standard pricing model with made-up inputs, and rounded; real quotes, spreads and fees will differ. Stock XYZ trades at $100, you are mildly bullish for the next month, implied volatility is 30% and the options have 30 days left. Here is the same view four ways, with the result at expiration.

Read the differences, not a winner. The long call and the spread risk a few hundred dollars and need the stock to rise. The cash-secured put and the covered call tie up about $9,500 to $10,000, can make money with the stock flat, and carry most of the risk of owning the shares. If XYZ ends at $85, the call loses $359 and the spread $293, while the put seller is down $867 and the covered call holder $1,333. You can run your own numbers in the options profit calculator.

  • Long call: buy the $100 call for $3.59 ($359). Maximum loss $359, breakeven $103.59, open-ended gain above it. If XYZ ends at $102, the trade still loses $159.
  • Bull call spread: buy the $100 call for $3.59 and sell the $110 call for $0.66, a net debit of $2.93 ($293). Maximum loss $293, breakeven $102.93, maximum gain $707 at $110 or higher.
  • Cash-secured put: sell the $95 put for $1.33 ($133) with $9,500 set aside. Maximum gain $133 if XYZ stays above $95, breakeven $93.67. Below $95 you buy 100 shares at $95; the worst case, XYZ at zero, is a $9,367 loss.
  • Covered call: own 100 shares at $100 and sell the $105 call for $1.67 ($167). Maximum gain $667 at $105 or higher, breakeven $98.33. Below that you lose like any shareholder, with a $167 cushion.

Which options strategies are best for beginners?

The strategies usually suggested first are the ones whose risk is easiest to see. Buying a call or a put risks only the premium. The covered call and the cash-secured put are simple to manage but carry the downside of owning shares, so use them only on stocks you would be comfortable holding through a sharp drop.

Defined-risk spreads come next: a vertical spread caps both the gain and the loss, and an iron condor puts two of them around a range. Event trades, such as a straddle bought before earnings, are harder than they look, because implied volatility often drops once the news is out. Leave uncovered selling alone until you fully understand assignment and margin, practice on paper first and keep each position small.

Common options strategy mistakes

These mistakes cost more than any choice of strategy:

  • Choosing the strategy before the view. Start from the outlook, the time frame and the maximum loss, then pick the structure.
  • Selling premium because options often expire worthless. Many small gains can be erased by one large loss, so size for the bad case, not the typical one.
  • Ignoring implied volatility. Buying when IV is high, or selling when it is low, changes the trade more than most beginners expect.
  • Forgetting events. Earnings and ex-dividend dates inside your expiration change the trade: IV often drops after earnings, and short calls can be assigned early before an ex-dividend date.
  • Legging into multi-leg trades one option at a time and getting stuck with half a position after the price moves. Enter spreads as one order where your broker allows it.
  • Trading illiquid strikes. Every leg pays the bid-ask spread, so a four-leg strategy on wide spreads starts well behind.