How to Invest in Options 5 of 5 Strategies

How to invest in options, continued
Strategies
Spread
Straddle
Naked Put Writing

Additional strategies involving the use of options
Options are very flexible tools for a wide range of strategies. Below is a brief introduction to some of the more common strategies involving a combination of options contracts.
Debit or Credit Spread: A spread is a transaction in which one simultaneously buys one option and sells another option, with different terms, on the same underlying security. In a call spread, the options are calls. The basic idea behind spreading is that the investor is using the sale of one call to reduce the risk of buying the other call. This strategy would be most useful if the investor was expecting a move in the stock but not a dramatic one. Spreads must generally be done in a margin account.
When a spread order is entered, the options being bought and sold must be specified as well as the price to be executed and whether that price is a debit or credit.
Calendar Spread: A calendar spread, also frequently known as a time spread, involves the sale of one option and the simultaneous purchase of a more distant option, both with the same strike price. The neutral philosophy for using calendar spreads is that time will erode more quickly on the near term options. If this happens, the spread will widen and a profit may result at near-term expiration.
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Straddle Buying: A straddle purchase consists of buying both a put and a call with the same terms. The purchase allows the buyer to make large potential profits if the stock moves far enough in either direction. The magnitude of the expected move must be enough to effectively pay the cost of both premiums and earn profits. This strategy would be particularly attractive when option premiums are low (implied volatility is relatively low). The buyer has a predetermined maximum loss, equal to the amount of his initial investment.
Straddle Selling: The sale of a straddle involves selling both a put and a call with the same terms. As with any type of option sale, the straddle sale may either be covered or uncovered. Both uses are fairly common. The covered sale of a straddle is very similar to the covered call writing strategy and would generally appeal to the same type of investor. The investor must be aware that while the call side of the straddle is covered, the put is not covered and the investor must be willing to buy the stock at the lower price if exercised upon. The uncovered straddle write is attractive to the more aggressive investor who is interested in selling large amounts of time premium in hopes of collecting larger profits if the underlying stock remains fairly stable. In this strategy the investors risk is not defined and therefore theoretically unlimited.
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Naked Put Writing: Some investors who wish to accumulate a stock at prices lower than today’s market may find writing naked puts useful. In this strategy the investor will sell naked puts to collect option premium and feel fully comfortable if exercised upon and forced to buy the stock lower. If the stock never drops to the options strike price, the investor was still able to collect and keep the option premium received.
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