If you’re already familiar with options, then you know that they are a type of contract that gives the trader the right to buy or sell some underlying stocks or assets at a predetermined price.
Buying and selling these options (contracts) is done through numerous strategies that can be either bullish, bearish, or neutral.
So, this article will cover some of the most common neutral options strategies and explain how they work. Let’s get started!
Neutral Options Strategies - A General Overview
Neutral or non-directional options strategies are simply defined as the attitude of an options trader when they want to “play it safe”.
In other words, the trader doesn’t know if the asset price will rise or fall in the future, so they make a calculated investment to limit their losses with neutral options strategies that depend on the price volatility of the stocks or assets.
The one major factor that market-neutral options strategies depend on is the price volatility of the asset or stock that is being traded.
What neutral strategy a trader uses will depend on their sense and prediction of that price volatility, but with a calculated risk. There are multiple non-directional strategies divided by the price volatility:
Neutral strategies that are profitable on high-price volatility
These neutral options strategy types are profitable whenever there is an extreme rise or a fall in the price of the stock or asset. They are:
- Long Straddle
- Long Strangle
- Short Butterfly Spread
- Short Condor Spread.
Neutral strategies that are profitable on low-price volatility
These neutral strategies are profitable whenever a certain stock or asset's price volatility stays within a certain range and are ideal for range-bound markets. They are:
- Short Straddle
- Short Strangle
- Long Butterfly Spread
- Long Condor Spread.
Neutral Options Strategies - A Detailed Overview
Let’s now look at each of the neutral options strategy types individually and see how they work in practice.
Straddle
A straddle is a simultaneous purchase of both a call and a put option at the same expiration date and strike price. The process involves the purchase of two separate option contracts, a call, and a put, for the same stock or asset.
Investors utilize the straddle strategy when predicting that the asset's price will have a volatile change or it will stay within a certain range. That is where two different straddle strategy types come in.
Long straddle
A long straddle involved purchasing a call and a put option with an identical expiration date and strike price. It is profitable when there is a volatile change in the price of the purchased option for the stock or asset.
The profit of a long straddle strategy can be increasingly high, with limited risk. The maximum loss is the buy price of both the call and the put options (the premium) plus any commissions.
Short straddle
A short straddle is contrary to a long straddle and involves writing (selling) a call and a put option with an identical expiration date and strike price.
Traders use the short straddle strategy when they believe the underlying stock price will lack volatility and stay in a certain range (between the break-even points ).
With this strategy, the potential profits are limited, while the potential losses can be unlimited, which is why it is recommended for experienced traders.
Strangle
Traders use the strangle strategy when they believe that the price of an asset or stock will move in an upward or downward direction, but with a certain level of assurance to minimize losses. In other words, they still want to be protected if things don’t go according to their prediction.
A strangle involves purchasing or selling a call and put option with different strike prices but the same expiration dates. This strategy also consists of a long strangle and a short strangle.
Long strangle
A long strangle is when you purchase one long call option with a greater strike price and a long put option with a lower strike price.
You gain a profit from the long strangle if the price of the asset or stock rises above or falls below the upper and lower break-even points, and it has the potential to be unlimited. In other words, if the price of the asset or stock is volatile, you stand to gain a substantial profit.
The maximum loss is when the strike price is between the two break-even points, up to the point of the options expiration date. The amount of the loss is the premium you pay for the options, plus commissions.
Short strangle
A short strangle is the contrary of a long strangle when you purchase a short call option with a greater strike price and a short put option with a lesser strike price, both with the same expiration date.
You profit from a short strangle strategy when the price of the stock or asset is between the upper and lower break-even points. The profit margin depends on the price's low volatility and the options' expiration date.
The potential losses are unlimited if the strike price goes above the upper break-even point and very high if the strike price goes below the lower break-even point.
Butterfly spread
The butterfly spread is one of the complex neutral options strategies many experienced traders use. It combines bull and bear spreads together and is a four-legged strategy.
Four-legged means a trader uses four options with the same expiration dates at three different strike prices. The risk of a butterfly spread strategy is fixed, and the profits and losses are capped.
There are two butterfly spread strategies, a long butterfly spread and a short butterfly spread.
Long butterfly spread
You can utilize a long butterfly spread with either calls or puts, which is recommended for lower-price volatility markets. For example:
- A long call butterfly spread is created when you purchase one in-the-money call option with a lesser strike price and one out-of-the-money call option with a greater strike price and simultaneously sell (writing) two at-the-money call options.
- A long put butterfly spread is created when you purchase one put with a lower strike price and one with a higher strike price while simultaneously selling two at-the-money put options.
Short butterfly spread
You can also use a short butterfly spread strategy with either calls or puts, which is recommended for highly volatile price markets. For example:
- A short call butterfly spread is created when you sell one in-the-money call option with a lesser strike price and one out-of-the-money call option with a greater strike price while simultaneously purchasing two at-the-money call options.
- A short put butterfly spread is created when you sell one out-of-the-money put option with a lesser strike price and one in-the-money put with a higher strike price while simultaneously purchasing two at-the-money put options.
Condor spread
Like the butterfly spread, a condor spread involves purchasing four options, with the difference that all options are bought or sold at different strike prices. It is a neutral options strategy that allows the trader to profit in high and low-volatile price markets.
Profits of a condor spread depend on whether you’re using a long call, put condor spread, or a short call or put condor spread. In any case, the profits depend on the volatility of the prices and the expiration date.
A condor spread can be long or short, using calls and puts.
Long condor spread
You can use a long condor spread with either calls or puts, which is recommended for lower price volatility markets. For example:
- A long call condor spread is created when you purchase one call with the lowest strike price and another with the highest strike price while simultaneously selling a call option with the second lowest strike price and another with the second highest strike price.
- A long put condor spread is created when you purchase one put option with the lowest strike price and one with the highest strike price. At the same time, you’re selling one put option with the second-lowest strike price and one with the second-highest strike price.
Short condor spread
You can also use a short condor spread with calls or puts, recommended for higher price volatility markets. For example:
- A short call condor spread is created when you sell one call with the lowest strike price and another call with the highest strike price while simultaneously purchasing one call with the second lowest strike price and another with the second highest strike price.
- A short put condor spread is created when you sell one put option with the lowest strike price and another put option with the highest strike price while simultaneously purchasing one put option with the second lowest strike price and another put option with the second highest strike price.
Conclusion
Congratulations, you now know the fundamentals of some of the most commonly used neutral options strategies.
With the knowledge you gained, you will be confident to try trading options, and there is no better platform to start than FoolProofOptions. Its simple and easy-to-use interface, paired with frequent trading alerts, will effortlessly get you into the world of options trading.
Good luck, and happy trading!