Module 4: Basic Options Strategies

Introduction

Now comes the exciting part: putting your options knowledge to work.

In Module 3, you learned the building blocks—what calls and puts are, how they work, and how to read an options chain. Now we'll combine these building blocks into strategies: specific ways to use options to achieve different goals.

Think of it this way: knowing what a hammer and saw are is useful, but knowing how to build a bookshelf is what creates value. Similarly, knowing what calls and puts are is foundational, but knowing when and how to use them is what makes you a trader.

In this module, we'll cover:

• Long calls and puts (directional speculation)
• Covered calls (income generation)
• Protective puts (portfolio insurance)
• Cash-secured puts (acquiring stock at a discount)

These four strategies form the foundation of options trading. Master these before moving to more complex strategies. Many successful traders use only these basic strategies for years—they work.

Each strategy includes:

• When to use it
• Step-by-step setup
• Risk and reward profile
• Real examples
• Common mistakes

Let's begin.

Strategy 1: Long Call (Buying Calls)

Overview

Market View: Bullish (you expect the stock to rise)

Objective: Profit from upward price movement with limited risk and leveraged returns

Risk Profile:

• Maximum loss: Premium paid (limited and defined)
• Maximum gain: Unlimited (theoretically)
• Breakeven: Strike price + premium paid

When to Use

Use long calls when:

• You're bullish on a stock but don't want to commit full capital
• You want leveraged exposure to upside
• You want defined risk (can't lose more than premium)
• You expect a significant move in a specific timeframe

Don't use long calls when:

• You're only mildly bullish (time decay will hurt)
• You can't handle losing 100% of the premium
• The stock is unlikely to move significantly

How to Set Up

Step 1: Choose your stock

• Pick a stock you believe will rise
• Ideally, have a specific catalyst (earnings, product launch, etc.)
• Check the stock's recent volatility and trend

Step 2: Select expiration date

• Give yourself enough time to be right
• Rule of thumb: 30-60 days minimum for directional trades
• Longer = more expensive but more time to be right

Step 3: Choose strike price

Your options:

At-the-money (ATM): Most balanced

• Maximum leverage for the price
• Highest delta (sensitivity to stock movement)
• Good liquidity

In-the-money (ITM): More conservative

• Already has intrinsic value
• Acts more like stock (less leverage)
• Higher probability of profit

Out-of-the-money (OTM): Most aggressive

• Cheapest option
• Highest percentage gains if right
• Highest probability of total loss

Step 4: Check liquidity

• Volume > 100 contracts
• Open interest > 500
• Bid-ask spread < 5% of option price

Step 5: Calculate costs and breakeven

• Total cost = Premium × 100 × Number of contracts
• Breakeven = Strike + Premium paid

Real Example: Long Call

Scenario: January 15

• Microsoft (MSFT) is trading at $380
• You believe earnings (in 4 weeks) will beat expectations
• You expect MSFT could reach $400+

Your Trade:

Buy 2 MSFT Call Options:

• Strike: $385 (slightly OTM)
• Expiration: February 16 (32 days away)
• Premium: $6.50 per share
• Total cost: $6.50 × 100 × 2 = $1,300

Risk Analysis:

• Maximum loss: $1,300 (if MSFT stays below $385)
• Breakeven: $385 + $6.50 = $391.50
• Maximum gain: Unlimited (theoretically)

Outcome Scenarios:

Scenario A: Bullish Case (MSFT at $405)

Your calls are now deep ITM:

• Intrinsic value: $405 - $385 = $20 per share
• Option value: ~$20 (assuming near expiration)
• Position value: $20 × 100 × 2 = $4,000
• Profit: $4,000 - $1,300 = $2,700 (208% return)

Compare to buying stock:

• 100 shares would cost $38,000
• Gain: ($405 - $380) × 100 = $2,500 (6.6% return)
• Options gave you 31× the return percentage!

Scenario B: Moderate Rise (MSFT at $395)

Your calls are moderately ITM:

• Intrinsic value: $395 - $385 = $10 per share
• Option value: ~$10-11 (small time value remains)
• Position value: ~$10.50 × 100 × 2 = $2,100
• Profit: $2,100 - $1,300 = $800 (62% return)

Scenario C: Small Rise (MSFT at $388)

Your calls are slightly ITM:

• Intrinsic value: $388 - $385 = $3 per share
• Option value: ~$3-4 (some time value remains)
• Position value: ~$3.50 × 100 × 2 = $700
• Loss: $1,300 - $700 = -$600 (46% loss)

Note: You're directionally correct (stock went up), but not enough to profit.

Scenario D: Stays Flat or Falls (MSFT at $380 or below)

Your calls expire worthless:

• No intrinsic value
• Loss: $1,300 (100% loss)

Payoff Diagram: Long Call

Profit/Loss

    +$3,000 |                                    /
            |                                   /
    +$2,000 |                                  /
            |                                 /
    +$1,000 |                                /
            |                               /
         $0 |_____________________________ /__________ Stock Price
            |                          /  $391.50
            |                         /   (Breakeven)
   -$1,300  |________________________/
            |                       /
            |  Max Loss = $1,300   /
            |                     /
            |____________________/
           $360  $370  $380  $385  $395  $405  $415
                           (Strike)

Key observations:

• Loss is limited to $1,300 no matter how low the stock goes
• Profit is unlimited as stock rises
• You need stock above $391.50 to profit
• Slope gets steeper above strike (1:1 with stock movement)

Tips for Success with Long Calls

1. Don't buy options that are too far OTM

Cheap options are tempting but usually unprofitable. A $1 option that expires worthless is a 100% loss, just like a $10 option.

2. Give yourself time

Don't buy weekly options unless you're very confident in immediate movement. 30-60 days gives you room to be right.

3. Take profits

Options can gain value quickly. If you're up 50-100%, consider taking some profit. Don't get greedy.

4. Set a stop loss

Decide in advance: "If I'm down 50%, I'll exit." This prevents holding worthless options hoping for a miracle.

5. Don't fight the trend

Long calls work best when the stock is in an uptrend. Fighting a downtrend with calls is expensive.

Common Mistakes

Mistake 1: Holding until expiration

Time decay accelerates near expiration. Exit with 1-2 weeks remaining to avoid extreme decay.

Mistake 2: Not adjusting for volatility

High implied volatility makes options expensive. You might be right about direction but lose money if volatility drops.

Mistake 3: Overtrading

One or two well-researched trades beat ten random trades. Quality over quantity.

Mistake 4: Risking too much capital

Never risk more than 2-5% of your trading capital on a single options trade.

Strategy 2: Long Put (Buying Puts)

Overview

Market View: Bearish (you expect the stock to fall)

Objective: Profit from downward price movement with limited risk

Risk Profile:

• Maximum loss: Premium paid (limited and defined)
• Maximum gain: Large (stock can fall to zero)
• Breakeven: Strike price - premium paid

When to Use

Use long puts when:

• You're bearish on a stock
• You want leveraged exposure to downside
• You want defined risk
• You expect a significant decline in a specific timeframe
• You want to profit from market declines without short selling

Advantages over short selling stock:

• Limited risk (shorts have unlimited risk)
• No borrowing required
• No margin calls
• Can't lose more than premium paid

How to Set Up

The setup is similar to long calls, but inverted:

Step 1: Choose your stock

• Pick a stock you believe will fall
• Look for deteriorating fundamentals, technical breakdowns, or negative catalysts

Step 2: Select expiration date

• 30-60 days minimum
• Longer if expecting a slow decline

Step 3: Choose strike price

At-the-money (ATM): Balanced approach In-the-money (ITM): More conservative, acts more like short stock Out-of-the-money (OTM): Aggressive, cheapest, highest risk

Step 4: Check liquidity (same as long calls)

Step 5: Calculate costs and breakeven

• Breakeven = Strike - Premium paid

Real Example: Long Put

Scenario: March 1

• Tesla (TSLA) is trading at $240
• Deliveries data coming in 3 weeks looks weak
• Competition is intensifying
• You expect TSLA could fall to $220 or below

Your Trade:

Buy 3 TSLA Put Options:

• Strike: $235 (slightly OTM)
• Expiration: March 29 (28 days away)
• Premium: $8.00 per share
• Total cost: $8.00 × 100 × 3 = $2,400

Risk Analysis:

• Maximum loss: $2,400 (if TSLA stays above $235)
• Breakeven: $235 - $8.00 = $227
• Maximum gain: $227 × 100 × 3 = $68,100 (if TSLA went to zero—unrealistic but theoretical max)

Outcome Scenarios:

Scenario A: Strong Decline (TSLA at $210)

Your puts are deep ITM:

• Intrinsic value: $235 - $210 = $25 per share
• Option value: ~$25
• Position value: $25 × 100 × 3 = $7,500
• Profit: $7,500 - $2,400 = $5,100 (213% return)

Scenario B: Moderate Decline (TSLA at $225)

Your puts are ITM:

• Intrinsic value: $235 - $225 = $10 per share
• Option value: ~$10-11
• Position value: ~$10.50 × 100 × 3 = $3,150
• Profit: $3,150 - $2,400 = $750 (31% return)

Scenario C: Small Decline (TSLA at $232)

Your puts are slightly ITM:

• Intrinsic value: $235 - $232 = $3 per share
• Option value: ~$3-4
• Position value: ~$3.50 × 100 × 3 = $1,050
• Loss: $2,400 - $1,050 = -$1,350 (56% loss)

Again, you're directionally correct but didn't profit.

Scenario D: Stays Flat or Rises (TSLA at $240+)

Your puts expire worthless:

• Loss: $2,400 (100% loss)

Payoff Diagram: Long Put

Profit/Loss

   +$10,000 |    /
            |   /
    +$8,000 |  /
            | /
    +$6,000 |/
            /|
    +$4,000/  |
           /   |
    +$2,000|   |
           |   |
         $0|___|________________________________ Stock Price
               |$227                  $235
               |(Breakeven)          (Strike)
    -$2,400 ___|________________________
               |   Max Loss = $2,400
               |
               |
            $200    $210    $220    $230    $240    $250

Key observations:

• Loss is limited to $2,400 no matter how high the stock rises
• Profit increases as stock falls (up to zero)
• You need stock below $227 to profit
• Maximum profit potential is large but capped at strike price

Puts as Portfolio Insurance

Long puts have a special use case: protecting stock you already own.

Example:

You own 300 shares of NVDA at $500 (worth $150,000). You're worried about a correction but don't want to sell due to:

• Tax implications
• Long-term bullish view
• Transaction costs

Solution: Buy protective puts (covered in Strategy 3)

Tips for Success with Long Puts

1. Understand bear market dynamics

Stocks can fall faster than they rise (fear > greed). Give yourself enough time, but realize moves can be quick.

2. Consider buying puts at resistance levels

Technical resistance can provide good entry points for puts.

3. Don't fight Fed support

When the Fed is actively supporting markets, betting on declines is harder. Respect the macro environment.

4. Volatility often rises as stocks fall

This helps put buyers—as stocks decline, volatility increases, boosting put values.

5. Take profits on big wins

If your puts double or triple quickly, consider taking profit. Bounces can erase gains fast.

Strategy 3: Covered Call (Selling Calls Against Stock You Own)

Overview

Market View: Neutral to slightly bullish (stock will stay flat or rise modestly)

Objective: Generate income from stocks you already own

Risk Profile:

• Maximum loss: Substantial (if stock crashes, minus premium received)
• Maximum gain: Limited to strike price + premium received
• Breakeven: Stock purchase price - premium received (over time)

Key requirement: You must own 100 shares of stock per contract

When to Use

Use covered calls when:

• You own stock and want to generate additional income
• You're willing to sell your stock at a higher price
• You believe stock will stay relatively flat or rise modestly
• You want to reduce your cost basis over time
• You're okay capping your upside potential

Don't use covered calls when:

• You expect the stock to surge (you'll miss the big move)
• You absolutely don't want to sell the stock
• The stock is in a strong uptrend (hold for bigger gains instead)

How It Works

A covered call is selling someone else the right to buy your stock at a specified price. You receive premium for this obligation.

If stock stays below strike: You keep your stock and the premium—free money!

If stock rises above strike: Your stock gets "called away" (sold at strike price). You still profit, just capped.

How to Set Up

Step 1: Own the stock (or buy it)

• You need 100 shares per contract
• 300 shares = can sell 3 contracts
• 550 shares = can sell 5 contracts (need multiples of 100)

Step 2: Choose strike price

Aggressive (lower strikes):

• Higher premium collected
• Higher probability of assignment (stock called away)
• Lower total return potential

Conservative (higher strikes):

• Lower premium collected
• Lower probability of assignment
• Higher total return potential if stock rises

Rule of thumb: Sell strikes 5-10% above current stock price

Step 3: Select expiration

Shorter expiration (weekly to 1 month):

• Lower premium per trade
• Can repeat monthly for consistent income
• More flexibility to adjust

Longer expiration (2-3 months):

• Higher premium per trade
• Locks you in longer
• Less management required

Most popular: 30-45 days (sweet spot for time decay)

Step 4: Sell the call

• "Sell to open" the call option
• Receive premium immediately (in your account)

Real Example: Covered Call

Scenario: June 1

• You own 400 shares of Apple (AAPL) at $180
• Stock is currently at $185
• You're willing to sell at $195 if it gets there
• You want to generate income while holding

Your Trade:

Sell 4 AAPL Covered Calls:

• Strike: $195 (5.4% above current price)
• Expiration: July 19 (48 days away)
• Premium: $3.20 per share
• Income received: $3.20 × 100 × 4 = $1,280

Risk Analysis:

• Income: $1,280 (instant, regardless of outcome)
• Maximum gain: ($195 - $185) × 400 + $1,280 = $5,280
• If assigned, return: $5,280 / $74,000 = 7.1% in 48 days (~54% annualized)
• Maximum loss: If AAPL crashes to $0 = $74,000 - $1,280 = $72,720 (but this risk exists whether you sell calls or not)

Outcome Scenarios:

Scenario A: Stock stays below $195 (AAPL at $192)

Outcome:

• Calls expire worthless
• You keep all 400 shares
• You keep the $1,280 premium
• Profit: $1,280 + ($192 - $185) × 400 = $1,280 + $2,800 = $4,080

Next step: Sell another round of covered calls for next month

Scenario B: Stock rises above $195 (AAPL at $202)

Outcome:

• Your calls get exercised (assigned)
• You sell 400 shares at $195
• You keep the $1,280 premium
• Total profit: ($195 - $185) × 400 + $1,280 = $5,280

You've capped your gains at $195, missing the move from $195 to $202

Missed opportunity: ($202 - $195) × 400 = $2,800

But you still made $5,280 in 48 days (7.1% return). Many investors would be thrilled with this.

Scenario C: Stock drops (AAPL at $178)

Outcome:

• Calls expire worthless
• You keep all 400 shares
• You keep the $1,280 premium
• Your shares are worth less: ($178 - $185) × 400 = -$2,800 unrealized loss
• Premium offsets some loss: -$2,800 + $1,280 = -$1,520 total

Key point: The covered call didn't cause the loss—the stock declining did. The call premium actually reduced your loss by $1,280.

Scenario D: Stock crashes (AAPL at $160)

Outcome:

• Calls expire worthless
• You keep shares (now worth less)
• You keep $1,280 premium
• Loss on stock: ($160 - $185) × 400 = -$10,000
• Net loss: -$10,000 + $1,280 = -$8,720

Important: Covered calls provide minimal downside protection. They're income strategies, not insurance strategies.

Payoff Diagram: Covered Call

Profit/Loss

    +$6,000 |              _______________  Max Gain
            |             /
    +$4,000 |            /
            |           /
    +$2,000 |          /
            |         /  Covered Call
         $0 |________/______________________________ Stock Price
            |       /  $180    $195
            |      /  (Cost)  (Strike)
    -$2,000 |     /
            |    / Stock Alone
    -$4,000 |   /
            |  /
    -$6,000 | /
            |/
        $160    $170    $180    $190    $200    $210

Key observations:

• Gains are capped at strike price + premium
• Loss protection = premium received (~$1,280)
• Below breakeven, you lose just like owning stock alone
• The covered call line is always $1,280 above the stock-only line

Rolling a Covered Call

What if the stock is about to blast through your strike and you don't want to sell?

Solution: Roll the call

Rolling means:

1. Buy back (close) the current short call
2. Sell (open) a new call with higher strike and/or later expiration

Example:

AAPL is at $194, about to breach your $195 strike with 1 week to expiration.

Current position: Short $195 call (worth $3.50 now)

Roll to:

• Buy to close $195 call at $3.50 (cost: $3.50 × 400 = -$1,400)
• Sell to open $200 call (August expiration) at $4.80 (receive: $4.80 × 400 = +$1,920)
• Net credit: $1,920 - $1,400 = $520

Result:

• You keep your shares
• Strike is now $200 (higher)
• Expiration extended to August (more time)
• Collected additional premium

Trade-off: You're locked in longer and could miss big rallies

Tips for Success with Covered Calls

1. Don't sell calls on your best stocks

If you own the next Apple or Amazon, don't cap your gains with covered calls. Save covered calls for stocks you're neutral on or okay selling.

2. Sell 30-45 days to expiration

This captures maximum time decay while maintaining flexibility.

3. Aim for 1-2% monthly premium

$100 stock, collect $1-2 per month in premium. Annualized, this is 12-24% additional return.

4. Be consistent

Covered calls work best when done systematically every month, compounding premiums over time.

5. Don't chase high premiums

Very high premiums usually mean high volatility or high probability of assignment. Stick to your plan.

6. Have an assignment plan

Before selling calls, decide: "If my stock gets called away, will I buy it back, move to a different stock, or take profits?"

Common Mistakes

Mistake 1: Selling calls on stocks you don't own (naked calls)

This is extremely risky. Always own the stock first. Naked calls have unlimited risk.

Mistake 2: Selling too far OTM for tiny premium

$0.10 per share premium is barely worth it. Aim for meaningful premium relative to your goals.

Mistake 3: Refusing to be assigned

Some traders continuously roll to avoid assignment, paying up each time. Sometimes it's better to let the stock go and move on.

Mistake 4: Selling calls right before earnings

Earnings can cause huge moves. If you don't want to miss upside, wait until after earnings to sell calls.

Strategy 4: Protective Put (Portfolio Insurance)

Overview

Market View: Neutral to bullish long-term, but worried about short-term decline

Objective: Protect stock you own from significant losses

Risk Profile:

• Maximum loss: Limited to (stock price - put strike) + put premium
• Maximum gain: Unlimited (stock can rise indefinitely, minus put cost)
• Acts like insurance: costs money but protects against disaster

Key requirement: You must own the stock you're protecting

When to Use

Use protective puts when:

• You own stock but fear a correction
• You want to hold long-term but are worried short-term
• You can't sell due to tax implications
• You're sitting on large gains and want to protect them
• Before a known risky event (earnings, economic data, etc.)

Real-world parallel: Homeowner's insurance

You pay an annual premium to protect against catastrophic loss. You hope you never use it, but you sleep better knowing you're protected.

How It Works

Buy a put option on stock you own. If the stock falls, your put gains value, offsetting stock losses.

Cost: Premium (this is your insurance cost) Benefit: Limits downside, keeps upside

How to Set Up

Step 1: Own the stock

• 100 shares per put contract
• Calculate how much of your position you want to protect

Step 2: Choose strike price

Higher strike (more expensive):

• More protection
• Higher cost
• Example: Stock at $100, buy $98 put (2% loss max)

Lower strike (cheaper):

• Less protection
• Lower cost
• Example: Stock at $100, buy $90 put (10% loss max)

Common approach: 5-10% below current stock price

Step 3: Select expiration

Longer term:

• More expensive
• Continuous protection
• Less management

Shorter term:

• Cheaper
• Need to keep rolling (re-buying)
• More active management

Step 4: Buy the put

• "Buy to open" the put option
• Pay premium upfront

Real Example: Protective Put

Scenario: September 15

• You own 500 shares of NVDA at $450 (worth $225,000)
• You've made huge gains (bought at $200)
• Worried about correction but don't want to sell (taxes + long-term bullish)
• New economic data coming that could trigger volatility

Your Trade:

Buy 5 NVDA Protective Puts:

• Strike: $430 (4.4% below current price)
• Expiration: October 20 (35 days away)
• Premium: $12.00 per share
• Total cost: $12.00 × 100 × 5 = $6,000

Risk Analysis:

• Maximum loss on stock: ($450 - $430) × 500 = $10,000
• Plus premium paid: $6,000
• Total maximum loss: $16,000 (7.1% of position value)
• Maximum gain: Unlimited minus $6,000 premium

Outcome Scenarios:

Scenario A: Stock crashes (NVDA at $380)

Without protective put:

• Loss: ($380 - $450) × 500 = -$35,000 (15.6% loss)

With protective put:

• Stock loss: -$35,000
• Put intrinsic value: ($430 - $380) × 500 = +$25,000
• Premium paid: -$6,000
• Net loss: -$16,000 (7.1% loss)

The put saved you $19,000!

Scenario B: Moderate decline (NVDA at $420)

Without protective put:

• Loss: ($420 - $450) × 500 = -$15,000 (6.7% loss)

With protective put:

• Stock loss: -$15,000
• Put intrinsic value: ($430 - $420) × 500 = +$5,000
• Premium paid: -$6,000
• Net loss: -$16,000 (7.1% loss)

Note: Loss is the same because you're still within your "deductible" (below the strike).

Scenario C: Stock stays flat (NVDA at $450)

• Stock: No gain or loss
• Put expires worthless
• Net loss: $6,000 (cost of insurance)

This is the "cost of peace of mind"—like paying homeowner's insurance and not having a fire.

Scenario D: Stock rises (NVDA at $480)

• Stock gain: ($480 - $450) × 500 = +$15,000
• Put expires worthless: -$6,000
• Net gain: $9,000 (4% gain)

You captured most of the upside, minus insurance cost.

Payoff Diagram: Protective Put

Profit/Loss

   +$20,000 |                              /
            |                            /  Stock + Put
            |                          /
   +$10,000 |                        /
            |                      /
         $0 |                    / $445
            |                  /  (Breakeven)
            |                /
   -$10,000 |              /__________________  Max Loss
            |            /  $430
            |          /  (Strike)
   -$20,000 |        /
            |      /  Stock Alone
   -$30,000 |    /
            |  /
   -$40,000 |/
            |
        $380    $400    $420    $440    $460    $480

Key observations:

• Loss is capped at $430 strike (minus stock cost basis)
• You pay $6,000 for this protection (shifts line down)
• Upside is unlimited (minus $6,000 premium)
• The "floor" under your position = strike price

Variations: How Much Protection?

Full protection: Buy puts covering all shares

• Most expensive
• Complete peace of mind
• Best for large concentrated positions

Partial protection: Buy puts covering 50% of shares

• Cheaper
• Partial downside protection
• Compromise approach

Tiered protection: Multiple strikes

• Example: Buy $440 puts and $420 puts
• Layered protection at different levels
• More sophisticated approach

Insurance vs. Speculation

Protective puts as insurance:

• You already own the stock
• Goal is protection, not profit
• You hope puts expire worthless
• Cost of doing business

Long puts as speculation:

• You don't own the stock
• Goal is to profit from decline
• You hope puts gain value
• Directional bet

These are psychologically and strategically different uses of the same instrument.

Tips for Success with Protective Puts

1. Think of it as insurance, not profit

You're paying for protection. Like car insurance, you hope you never "profit" from it.

2. Time your purchases

Buy protection when:

• Volatility is low (cheaper premiums)
• Before known risk events
• When you're sitting on large gains

3. Use sparingly

Constantly buying puts is expensive. Reserve for:

• Concentrated positions
• Significant unrealized gains
• Periods of high uncertainty

4. Consider alternatives

Sometimes selling covered calls or just selling 10% of your position is more cost-effective than buying puts.

5. Calculate the cost as percentage

$6,000 on a $225,000 position = 2.67% for 35 days of protection. Annualized, that's ~28% of your position value. Is that worth it for your situation?

Strategy 5: Cash-Secured Put (Selling Puts)

Overview

Market View: Bullish or neutral (willing to own stock at lower price)

Objective: Generate income or acquire stock at a discount

Risk Profile:

• Maximum loss: Large (if stock crashes to zero)
• Maximum gain: Premium received
• Breakeven: Strike price - premium received

Key requirement: Cash in account to buy stock if assigned (strike price × 100 × contracts)

When to Use

Use cash-secured puts when:

• You want to buy a stock but wish it were cheaper
• You're willing to buy at strike price
• You want to generate income while waiting
• You're bullish or neutral on the stock

Don't use when:

• You don't actually want to own the stock
• You don't have cash to cover assignment
• The stock is in a strong downtrend

How It Works

You sell someone the right to sell you stock at the strike price. You receive premium for taking on this obligation.

If stock stays above strike: Put expires worthless, you keep premium (free income!)

If stock falls below strike: You buy stock at strike price (minus premium received), effectively acquiring it at a discount

How to Set Up

Step 1: Choose a stock you want to own

• Must genuinely be willing to own it
• Check fundamentals—would you buy it today?
• Have capital ready (cash-secured)

Step 2: Determine your desired purchase price

Current stock price: $100 You wish you could buy at: $95

Sell the $95 strike put

Step 3: Select expiration

30-45 days is sweet spot (balance premium vs. time commitment)

Step 4: Calculate premium income

Example: $95 put trading at $2.50

• Income: $2.50 × 100 = $250 per contract
• If assigned, effective purchase price: $95 - $2.50 = $92.50

Step 5: Ensure cash is available

Need $95 × 100 = $9,500 per contract in cash

Step 6: Sell the put

• "Sell to open" the put option
• Receive premium immediately

Real Example: Cash-Secured Put

Scenario: August 10

• Disney (DIS) is trading at $95
• You'd love to own it but think it might pull back
• You'd happily buy at $90
• You have $18,000 cash available

Your Trade:

Sell 2 DIS Cash-Secured Puts:

• Strike: $90 (5.3% below current price)
• Expiration: September 14 (35 days away)
• Premium: $1.80 per share
• Income received: $1.80 × 100 × 2 = $360

Cash required: $90 × 100 × 2 = $18,000 (you have this)

Risk Analysis:

• Income: $360 (instant, no matter what)
• If assigned, effective purchase price: $90 - $1.80 = $88.20
• Maximum loss: If DIS goes to $0 = $88.20 × 200 = $17,640
• Return if not assigned: $360 / $18,000 = 2% in 35 days (~21% annualized)

Outcome Scenarios:

Scenario A: Stock stays above $90 (DIS at $94)

Outcome:

• Puts expire worthless
• You keep $360 premium
• You don't own the stock
• Profit: $360 (2% return in 35 days)

Next step: Sell another round of puts, collecting more premium while waiting to own the stock

Scenario B: Stock falls slightly below $90 (DIS at $88)

Outcome:

• Puts get assigned
• You buy 200 shares at $90 = $18,000
• Effective cost: $90 - $1.80 = $88.20 per share
• Current value: $88 × 200 = $17,600
• Unrealized loss: $18,000 - $17,600 = $400
• But you own the stock you wanted!

Analysis:

• You're down $400, but you wanted to own DIS
• Your cost basis ($88.20) is better than if you'd bought at $95
• You saved $6.80 per share by waiting and collecting premium
• If you believe in DIS long-term, this is a win

Scenario C: Stock falls significantly (DIS at $80)

Outcome:

• Puts get assigned
• You buy 200 shares at $90 = $18,000
• Effective cost: $88.20 per share
• Current value: $80 × 200 = $16,000
• Unrealized loss: $18,000 - $16,000 = $2,000

Analysis:

• This hurts, but it's no different than if you'd bought stock outright at $88.20
• The put didn't create this risk—buying stock at any price has downside risk
• The $360 premium reduced your loss by that amount

Scenario D: Stock rises significantly (DIS at $105)

Outcome:

• Puts expire worthless
• You keep $360 premium
• You don't own the stock
• "Lost opportunity": You missed buying at $95

Analysis:

• You made $360 but didn't get the stock
• Missed out on ($105 - $90) × 200 = $3,000 gain
• This is the trade-off: income vs. missing the stock

Payoff Diagram: Cash-Secured Put

Profit/Loss

      +$360 |________________  Max Gain
            |
         $0 |________________|_____________ Stock Price
            |               $88.20  $90
            |              (Breakeven) (Strike)
            |                 |
    -$2,000 |                 |
            |                 | 
    -$4,000 |                 |
            |                 |
    -$6,000 |                 |
            |                 |  Short Put
    -$8,000 |                 |\
            |                 | \
   -$10,000 |                 |  \
            |                 |   \
        $70       $80       $90      $100      $110

Key observations:

• Gain is capped at premium received
• Loss increases as stock falls (similar to owning stock)
• Breakeven is below strike by amount of premium
• Obligation to buy stock if assigned

Cash-Secured Puts vs. Limit Orders

Traditional approach: Place limit order to buy at $90

Risks:

• Stock might never reach $90 (missed opportunity)
• No income while waiting

Cash-secured put approach: Sell $90 put

Benefits:

• Get paid premium while waiting ($360)
• Still buy at $90 if stock drops there
• Generate income even if stock never drops

Trade-off: If stock drops significantly, you must buy

Turning Assignment into Opportunity

What to do if assigned:

Option 1: Hold the stock

• You wanted to own it anyway
• Wait for recovery
• Potentially sell covered calls for additional income

Option 2: Sell immediately

• Take the loss if you've changed your view
• Sometimes the right move

Option 3: Sell covered calls

• Now that you own 200 shares, sell 2 covered calls
• Generate income to lower cost basis further
• This is called "the wheel strategy" (covered in advanced courses)

Tips for Success with Cash-Secured Puts

1. Only sell puts on stocks you actually want to own

Don't sell puts just for premium. If assigned, you're stuck with the stock.

2. Have a plan for assignment

Before selling the put: "If I get assigned, I will..."

3. Check support levels

Sell puts at or near technical support levels where stock is likely to bounce.

4. Don't chase high premiums

High premiums = high implied volatility = stock could crash. Be selective.

5. Laddering

Instead of selling all puts at once, stagger them:

• Week 1: Sell $90 puts
• Week 2: Sell $92 puts
• Week 3: Sell $88 puts

This spreads your risk and increases average premium.

6. Consider the 1% rule

Aim to collect at least 1% of strike price as premium. Less than that may not be worth the risk.

Common Mistakes

Mistake 1: Selling puts without cash available

This is a margin violation and forces liquidation. Always ensure cash to cover assignment.

Mistake 2: Selling puts on stocks you don't want to own

Assignment will happen eventually. Make sure you're okay with it.

Mistake 3: Selling puts in a downtrend

"Catching a falling knife." Wait for stabilization first.

Mistake 4: Not having an exit plan

If the stock crashes 20% below your strike, will you:

• Take assignment and hold?
• Buy back the put at a loss?
• Roll to lower strike?

Decide in advance.

Comparing the Basic Strategies

Quick Reference Table

Strategy	Market View	Max Profit	Max Loss	Best For
Long Call	Bullish	Unlimited	Premium paid	Leveraged upside
Long Put	Bearish	Large	Premium paid	Leveraged downside
Covered Call	Neutral/Bullish	Limited	Substantial	Income generation
Protective Put	Neutral/Bullish	Unlimited	Limited	Portfolio insurance
Cash-Secured Put	Bullish/Neutral	Premium	Large	Stock acquisition

When to Use Each Strategy

Use long calls when:

• Strong bullish conviction
• Want leverage
• Limited capital
• Specific short-term catalyst

Use long puts when:

• Strong bearish conviction
• Want leverage
• Don't want to short stock
• Expect significant decline

Use covered calls when:

• Own stock, neutral outlook
• Want additional income
• Willing to cap upside
• Stock in trading range

Use protective puts when:

• Own stock, worried short-term
• Have unrealized gains to protect
• Known risk event approaching
• Can't/won't sell stock

Use cash-secured puts when:

• Want to own stock cheaper
• Bullish but patient
• Want income while waiting
• Have cash available

Key Takeaways

Before moving to Module 5, ensure you understand:

✓ Long calls and puts provide leveraged exposure with defined risk

✓ Covered calls generate income but cap upside—only use on stocks you're willing to sell

✓ Protective puts act as insurance—they cost money but protect against large losses

✓ Cash-secured puts let you acquire stock at a discount while generating income

✓ Each strategy has specific market conditions where it excels

✓ Risk management requires understanding maximum loss, maximum gain, and breakeven for every trade

✓ Position sizing is critical—never risk more than you can afford to lose

✓ Having an exit plan before entering is essential for all strategies

Self-Check Questions

Test your understanding:

1. You're bullish on a stock but only want to risk $500. Which strategy should you use?

   Click to reveal answer

   Long call. This gives you leveraged upside exposure with defined risk (maximum loss = $500 premium paid). It's the most capital-efficient way to express bullish conviction with limited risk.

2. You own 300 shares of a stock worth $150 per share. You want to generate income but are okay selling at $165. What strategy do you use?

   Click to reveal answer

   Covered calls. Sell 3 call contracts with a $165 strike. You'll receive premium immediately and if the stock reaches $165, your shares will be called away at that price (your desired exit).

3. You own a stock that's up 200% and you're worried about a correction but don't want to sell due to taxes. What strategy protects you?

   Click to reveal answer

   Protective put. Buy put options at a strike below current price. This acts as insurance, limiting your downside while keeping unlimited upside (minus the put premium).

4. If you sell a cash-secured put with a $50 strike for $2 premium, what's your effective purchase price if assigned?

   Click to reveal answer

   $48 per share. Strike price ($50) minus premium received ($2) = $48 effective cost basis if you're assigned and must buy the stock.

5. True or False: A covered call completely protects you from downside risk.

   Click to reveal answer

   False. A covered call provides minimal downside protection (only the premium received). If the stock crashes, you still lose money. Covered calls are for income generation, not downside protection. Use protective puts for real downside protection.

Practice Exercise: Strategy Selection

For each scenario, identify the most appropriate basic strategy and explain why:

Scenario 1: You believe Apple will announce breakthrough AI features in 2 weeks and the stock will surge from $180 to $200+. You have $1,000 to invest.

Scenario 2: You own 500 shares of Microsoft at $350 (currently $380). You're long-term bullish but worried about an upcoming Fed decision next month that could cause a 10-15% correction.

Scenario 3: You own 400 shares of Tesla at $220 and you're happy holding it. The stock is currently at $250 and seems to be in a range. You want to generate extra income.

Scenario 4: You think the S&P 500 is due for a 5-10% correction over the next month. You want to profit from this view with limited risk.

Scenario 5: You want to buy Nvidia but it's at $500 and you wish it were at $475. You have $47,500 in cash and you're willing to wait.

Solutions:

Click to reveal detailed solutions

Scenario 1: Long Call

Why: You're bullish with a specific catalyst, want leverage, and have limited capital.

Execution:

• Buy Apple calls, strike $185-190
• Expiration: 3-4 weeks out (giving time beyond announcement)
• With $1,000, you could buy 2-3 contracts
• If stock reaches $200, your $1,000 could become $2,000-3,000
• Maximum loss: $1,000

Alternative considered: Buying stock. But $1,000 only buys 5-6 shares ($180 each), gaining only $100-120 if stock hits $200. The call provides much better leverage.

Scenario 2: Protective Put

Why: You want downside protection while maintaining upside. You can't sell due to taxes and you believe in the long-term, so you need insurance.

Execution:

• Buy 5 protective puts on Microsoft
• Strike: $360-365 (5-6% below current $380)
• Expiration: 45-60 days (covering the Fed decision plus some buffer)
• Cost: Perhaps $8-10 per share = $4,000-5,000 total
• This limits your maximum loss to ~$15-20 per share plus premium
• If stock rises, you participate minus the premium cost

Alternative considered: Covered calls don't provide real downside protection. Selling the stock triggers taxes. Protective puts are the right tool.

Scenario 3: Covered Call

Why: You own the stock, want income, stock is range-bound, and you're happy to sell at higher prices.

Execution:

• Sell 4 covered calls on Tesla
• Strike: $265-270 (6-8% above current $250)
• Expiration: 30-45 days
• Premium: Perhaps $5-7 per share = $2,000-2,800 total
• If stock stays below strike, you keep premium and repeat monthly
• If stock exceeds strike, you sell at $265-270 + keep premium = excellent return
• Annualized, this could add 12-20% to your returns

Alternative considered: Just holding is fine, but covered calls add income with minimal downside since you're already owning the stock.

Scenario 4: Long Put

Why: You're bearish, want defined risk, and want leverage on the downside.

Execution:

• Buy puts on SPY (S&P 500 ETF)
• Strike: 5% below current level
• Expiration: 45 days (enough time for correction to play out)
• Risk: Premium paid (perhaps $2,000-3,000)
• Reward: If S&P drops 10%, puts could gain 100-200%

Alternative considered: Shorting stocks has unlimited risk. Long puts provide the same bearish exposure with defined, limited risk.

Scenario 5: Cash-Secured Put

Why: You want to buy the stock cheaper, you're patient, you have the cash, and you can generate income while waiting.

Execution:

• Sell 1 NVDA cash-secured put
• Strike: $475 (your desired purchase price)
• Expiration: 30-45 days
• Premium: Perhaps $12-15 per share = $1,200-1,500
• Cash required: $47,500 (you have this)

Outcomes:

• If NVDA stays above $475: Keep premium, sell another put next month
• If NVDA drops to $475: You buy at $475 - $12 = $463 effective price, better than the current $500!

Alternative considered: Just placing a limit order at $475 generates no income while you wait and might never fill if stock doesn't drop.

What's Next?

Excellent work! You now have a toolkit of five foundational options strategies. You understand when to use each one, how to set them up, and what results to expect.

These strategies alone can serve you for years. Many successful traders build entire careers using just these basics, executed consistently with good risk management.

But to truly master options trading, you need to understand what makes options valuable. How are they priced? What factors affect their value? Why does an at-the-money option cost more than an out-of-the-money option?

In Module 5: Understanding Options Pricing, we'll dive deep into the mechanics of option valuation. You'll learn about "The Greeks" (Delta, Gamma, Theta, Vega), understand implied volatility, and develop an intuitive feel for what makes options expensive or cheap.

This knowledge will transform you from someone who can execute strategies to someone who understands why options behave the way they do—and how to exploit that behavior.

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Ready to continue? Proceed to Module 5: Understanding Options Pricing