Module 6: Intermediate Options Strategies
Introduction
You've mastered the basics: buying calls and puts, selling covered calls, using protective puts. These single-option strategies are powerful, but they're just the beginning.
Now we enter the world of multi-leg strategies—combining multiple options to create positions with specific risk/reward profiles. These strategies let you:
- Profit when stocks move sideways (not just up or down)
- Reduce the cost of directional bets
- Define maximum risk and reward precisely
- Take advantage of volatility changes
- Generate consistent income in range-bound markets
Professional traders live in this world. They rarely trade single options. Instead, they construct positions that express nuanced views: "I think the stock will rise moderately but not surge," or "I expect the stock to stay within a range," or "I want to profit from declining volatility."
This module covers:
- Vertical Spreads (bull call, bear put, credit spreads)
- Horizontal Spreads (calendar spreads)
- Diagonal Spreads (combining vertical and horizontal)
- Straddles and Strangles (volatility plays)
- Iron Condors (range-bound strategies)
- Butterfly Spreads (precision betting)
Each strategy includes:
- Market view and when to use
- Construction and mechanics
- Risk/reward analysis
- Greeks profile
- Real examples
- Adjustment techniques
These strategies are more complex, but they're also more sophisticated tools for expressing precise market views. Take your time with this module—it's dense but incredibly valuable.
Understanding Spreads: The Foundation
Before diving into specific strategies, let's understand what a "spread" is.
What Is a Spread?
Definition: A spread is simultaneously buying and selling options on the same underlying stock, creating a position with defined risk and reward.
Why use spreads?
- Reduce cost: Selling an option offsets the cost of buying one
- Define risk: Maximum loss and gain are both capped
- Lower capital requirement: Spreads require less margin than naked positions
- Reduce sensitivity to Greeks: Offsetting positions neutralize some Greek exposure
Types of spreads:
- Vertical spread: Same expiration, different strikes
- Horizontal spread (calendar): Different expiration, same strike
- Diagonal spread: Different expiration AND different strikes
Spread Terminology
Debit spread: You pay money to enter (net debit)
- You buy the more expensive option
- You sell the cheaper option
- Example: Buy $100 call for $5, sell $110 call for $2 = $3 debit
Credit spread: You receive money to enter (net credit)
- You sell the more expensive option
- You buy the cheaper option
- Example: Sell $100 put for $5, buy $90 put for $2 = $3 credit
Width: The distance between strikes
- $100/$110 spread = $10 width
- Wider spreads = more capital at risk but more profit potential
Long vs. Short:
- Long spread: You want the spread to widen in value (debit spreads)
- Short spread: You want the spread to narrow in value (credit spreads)
Strategy 1: Bull Call Spread (Vertical Debit Spread)
Overview
Market View: Moderately bullish (stock will rise but not surge)
Construction:
- Buy a call (lower strike)
- Sell a call (higher strike)
- Same expiration
Risk Profile:
- Maximum loss: Net debit paid (limited)
- Maximum gain: Spread width - debit paid (limited)
- Breakeven: Long strike + net debit
Why Use It?
Compared to long call:
- Cheaper (reduce cost by selling upside call)
- Lower breakeven (less stock movement needed)
- Capped upside (trade-off for reduced cost)
Best for:
- Moderate bullish conviction (not expecting huge move)
- Expensive options environment (reduce cost)
- Want defined risk/reward
Construction Example
Stock: NVDA at $500
Your Trade:
- Buy 1 NVDA $500 Call @ $25
- Sell 1 NVDA $520 Call @ $15
- Net debit: $25 - $15 = $10 ($1,000 per spread)
- Expiration: 45 days
Position analysis:
Maximum loss: $10 per share = $1,000 per spread
- Occurs if stock stays below $500 at expiration
- Both options expire worthless
Maximum gain: ($520 - $500) - $10 = $10 per share = $1,000 per spread
- Occurs if stock above $520 at expiration
- Spread achieves maximum width
Breakeven: $500 + $10 = $510
Risk/Reward: 1:1 ($1,000 risk for $1,000 potential gain)
Payoff Diagram
Profit/Loss
+$1,000 | _______________ Max Gain
| /
+$500| /
| /
$0|___________/__________________ Stock Price
| $510 $520
| (BE) (Short Strike)
-$500|
|
-$1,000 |_______ Max Loss
|
|
$480 $500 $520 $540
(Long Strike)
Outcome Scenarios
Scenario A: Strong bullish move (NVDA at $540)
Both options are ITM:
- Long $500 call: $40 intrinsic value
- Short $520 call: -$20 intrinsic value (you owe this)
- Net value: $40 - $20 = $20
- Profit: $20 - $10 (debit) = $10 per share = $1,000 max gain
Notice: Stock went to $540, but you only profit up to $520. You capped your gains by selling the $520 call.
Scenario B: Moderate bullish move (NVDA at $515)
Both options are ITM:
- Long $500 call: $15 intrinsic value
- Short $520 call: $0 intrinsic value
- Net value: $15
- Profit: $15 - $10 = $5 per share = $500
Scenario C: Small move (NVDA at $505)
Only long call is ITM:
- Long $500 call: $5 intrinsic value
- Short $520 call: $0 intrinsic value
- Net value: $5
- Loss: $5 - $10 = -$5 per share = -$500
You're directionally correct but didn't reach breakeven.
Scenario D: Stock unchanged or down (NVDA at $495)
Both options expire OTM:
- Both worthless
- Loss: $10 per share = -$1,000 (max loss)
Greeks Profile
Delta: Positive but less than a long call alone
- Initial Delta: ~0.25 to 0.35
- You benefit from upside but less dramatically than long call
Theta: Negative (time decay hurts)
- But less negative than long call alone
- The short call you sold collects some Theta
Vega: Positive but reduced
- Rising IV helps but less than long call alone
- The short call you sold has negative Vega
Net effect: More stable, less affected by time and volatility than naked long call.
When to Use Bull Call Spread
Use when:
- Moderately bullish (expect 5-15% gain, not 30%+)
- IV is high (long call too expensive)
- Want defined risk
- Don't want to risk 100% of premium
Avoid when:
- Expecting huge move (you'll cap your gains)
- IV is very low (single long call is cheap anyway)
- Need unlimited upside potential
Management and Exit
Profit target: Exit at 50-75% of max gain
- If you can capture $500-750 of the $1,000 max gain, consider closing
- Why risk the rest?
Stop loss: Exit at 50% of max loss
- Down $500 of potential $1,000 loss? Cut it.
- Don't hold hoping for a miracle
Early assignment risk: If short call goes deep ITM before expiration
- Can be assigned early (though rare)
- Have plan to close or exercise long call
Adjustment: If stock surges past short strike early, consider:
- Taking profit (achieved most of max gain)
- Rolling short call higher (collect more credit, raise ceiling)
Real Example with Numbers
January 15: AAPL at $180
Enter bull call spread:
- Buy $180 call @ $8
- Sell $190 call @ $3
- Net debit: $5 ($500 per spread)
- Expiration: February 16 (32 days)
Risk/Reward:
- Max loss: $500
- Max gain: ($190 - $180) - $5 = $500
- Breakeven: $185
February 10 (1 week before expiration): AAPL at $188
Current value:
- $180 call: $9 intrinsic + $1 time = $10
- $190 call: $0 intrinsic + $1 time = $1
- Spread value: $10 - $1 = $9
Your profit: $9 - $5 = $4 per share = $400 (80% of max gain)
Decision: Close the position, take the $400 profit. Don't risk it for the final $100.
Action:
- Sell to close $180 call @ $10
- Buy to close $190 call @ $1
- Net credit: $9 (exit)
- Total profit: $9 - $5 = $4 = $400
Strategy 2: Bear Put Spread (Vertical Debit Spread)
Overview
Market View: Moderately bearish (stock will fall but not crash)
Construction:
- Buy a put (higher strike)
- Sell a put (lower strike)
- Same expiration
Risk Profile:
- Maximum loss: Net debit paid (limited)
- Maximum gain: Spread width - debit paid (limited)
- Breakeven: Long strike - net debit
This is the bearish mirror image of the bull call spread.
Why Use It?
Compared to long put:
- Cheaper (reduce cost by selling downside put)
- Lower breakeven
- Capped downside profit (trade-off for reduced cost)
Best for:
- Moderate bearish conviction
- Expensive options environment
- Want defined risk/reward
Construction Example
Stock: TSLA at $250
Your Trade:
- Buy 1 TSLA $250 Put @ $12
- Sell 1 TSLA $230 Put @ $6
- Net debit: $12 - $6 = $6 ($600 per spread)
- Expiration: 45 days
Position analysis:
Maximum loss: $6 per share = $600 per spread
- Occurs if stock stays above $250 at expiration
Maximum gain: ($250 - $230) - $6 = $14 per share = $1,400 per spread
- Occurs if stock below $230 at expiration
Breakeven: $250 - $6 = $244
Risk/Reward: Better than 2:1 ($600 risk for $1,400 potential gain)
Payoff Diagram
Profit/Loss
+$1,400 |_____________ Max Gain
| \
+$700 | \
| \
$0|_________________\____________ Stock Price
| $230 $244
| (Short) (BE)
-$300| \
| \
-$600|_______________________\____ Max Loss
|
$220 $230 $240 $250 $260
(Long Strike)
Outcome Scenarios
Scenario A: Strong bearish move (TSLA at $220)
Both puts are ITM:
- Long $250 put: $30 intrinsic value
- Short $230 put: -$10 intrinsic value (you owe this)
- Net value: $30 - $10 = $20
- Profit: $20 - $6 = $14 per share = $1,400 max gain
Scenario B: Moderate bearish move (TSLA at $235)
Both puts are ITM:
- Long $250 put: $15 intrinsic value
- Short $230 put: $5 intrinsic value (you owe this)
- Net value: $15 - $5 = $10
- Profit: $10 - $6 = $4 per share = $400
Scenario C: Small decline (TSLA at $246)
Only long put is ITM:
- Long $250 put: $4 intrinsic value
- Short $230 put: $0 intrinsic value
- Net value: $4
- Loss: $4 - $6 = -$2 per share = -$200
Scenario D: Stock unchanged or up (TSLA at $255)
Both puts expire OTM:
- Loss: $6 per share = -$600 (max loss)
Tips for Bear Put Spreads
1. Strike selection matters
Aggressive (lower strikes):
- Cheaper
- Further to breakeven
- Higher max gain relative to cost
Conservative (strikes closer to money):
- More expensive
- Closer breakeven
- Lower max gain relative to cost
2. Don't hold to expiration
Exit at 50-75% of max profit. If you've made $1,000 of potential $1,400, take it.
3. Manage losers early
If stock rallies against you and spread loses 50% of value, cut it. Don't hope.
4. Watch for volatility crush
If you enter before earnings with high IV, expect IV crush even if you're directionally correct.
Strategy 3: Bull Put Spread (Vertical Credit Spread)
Overview
Market View: Neutral to bullish (stock will stay flat or rise)
Construction:
- Sell a put (higher strike) - collect premium
- Buy a put (lower strike) - protection
- Same expiration
Risk Profile:
- Maximum loss: Spread width - credit received (limited)
- Maximum gain: Net credit received (limited)
- Breakeven: Short strike - net credit
Why Use It?
This is the opposite of a bear put spread:
- You receive money upfront (credit)
- Profit if stock stays flat or rises
- Want stock to stay above short strike
Best for:
- Neutral to bullish outlook
- Want to collect premium
- High IV environment
- Don't expect stock to fall
Construction Example
Stock: DIS at $95
Your Trade:
- Sell 1 DIS $90 Put @ $3
- Buy 1 DIS $80 Put @ $0.80
- Net credit: $3.00 - $0.80 = $2.20 ($220 per spread)
- Expiration: 45 days
Position analysis:
Maximum gain: $2.20 per share = $220 per spread
- Occurs if stock stays above $90 at expiration
- Both puts expire worthless, you keep credit
Maximum loss: ($90 - $80) - $2.20 = $7.80 per share = $780 per spread
- Occurs if stock below $80 at expiration
Breakeven: $90 - $2.20 = $87.80
Risk/Reward: ~3.5:1 risk/reward ($780 risk for $220 gain)
This is inverted compared to debit spreads! You're accepting more risk for smaller but probable gains.
Payoff Diagram
Profit/Loss
+$220 |_______________ Max Gain
| \
+$110| \
| \
$0|__________________\___________ Stock Price
| $80 $87.80 $90
| (Long) (BE) (Short)
-$390| \
| \
-$780|__________________________\___ Max Loss
|
$75 $85 $95 $105
When to Use Bull Put Spread
Use when:
- Neutral to bullish (don't expect decline)
- IV is high (collect good premium)
- Want income with defined risk
- Believe stock has support at short strike
Avoid when:
- Bearish on stock
- IV is low (collecting little premium)
- Stock breaking down technically
The Psychology of Credit Spreads
Key difference from debit spreads:
Debit spread: You pay $500 to make $500 (1:1) Credit spread: You collect $220 to risk $780 (~3.5:1)
This feels backwards! You're risking more than you can gain.
Why it works:
- Probability is in your favor
- Stock has to fall significantly for max loss
- Most spreads expire at max profit (short strike not breached)
Think of it like insurance:
- Insurance companies collect $1,000 premiums
- Risk paying out $100,000 in claims
- But most policies expire without claims
- They profit over time through probability
Management Tips
1. Exit at 50-75% of max gain
Collected $220 credit, now can buy back for $55-110? Take it!
Why: You've captured most profit and free up capital for new trades.
2. Don't let winners turn into losers
If spread is worth $20 (started at $220), and stock starts declining toward your short strike, consider closing. Don't let $200 profit turn into $780 loss.
3. Set stop losses
If spread goes to 2× your credit (e.g., $440 when you collected $220), close it. You've lost, move on.
4. Roll if needed
If stock threatens short strike, you can:
- Roll down (lower strikes, same expiration)
- Roll out (same strikes, later expiration)
- Roll down and out (both)
This takes loss but avoids max loss.
Real Example
March 1: MSFT at $380
Enter bull put spread:
- Sell $370 put @ $5
- Buy $360 put @ $2.50
- Net credit: $2.50 ($250 per spread)
- Expiration: March 29 (28 days)
Risk/Reward:
- Max gain: $250 (if MSFT stays above $370)
- Max loss: ($370 - $360) - $2.50 = $750 (if MSFT below $360)
- Breakeven: $367.50
- Probability: ~70-75% success (based on Delta)
March 20 (9 days before expiration): MSFT at $378
Current value:
- $370 put: $0.50
- $360 put: $0.10
- Spread value: $0.50 - $0.10 = $0.40
Your profit: $2.50 - $0.40 = $2.10 per share = $210 (84% of max gain)
Decision: Close early, keep $210. Why risk it for the final $40?
Action:
- Buy to close $370 put @ $0.50
- Sell to close $360 put @ $0.10
- Net debit: $0.40 (exit)
- Total profit: $2.50 - $0.40 = $210
Strategy 4: Bear Call Spread (Vertical Credit Spread)
Overview
Market View: Neutral to bearish (stock will stay flat or fall)
Construction:
- Sell a call (lower strike) - collect premium
- Buy a call (higher strike) - protection
- Same expiration
Risk Profile:
- Maximum loss: Spread width - credit received (limited)
- Maximum gain: Net credit received (limited)
- Breakeven: Short strike + net credit
This is the bearish mirror of the bull put spread.
Construction Example
Stock: NVDA at $500
Your Trade:
- Sell 1 NVDA $510 Call @ $8
- Buy 1 NVDA $520 Call @ $4
- Net credit: $8 - $4 = $4 ($400 per spread)
- Expiration: 30 days
Position analysis:
Maximum gain: $4 per share = $400 per spread
- Occurs if stock stays below $510 at expiration
Maximum loss: ($520 - $510) - $4 = $6 per share = $600 per spread
- Occurs if stock above $520 at expiration
Breakeven: $510 + $4 = $514
Risk/Reward: 1.5:1 risk/reward ($600 risk for $400 gain)
When to Use Bear Call Spread
Use when:
- Neutral to bearish (don't expect rally)
- IV is high (collect good premium)
- Stock at resistance level
- Want income with defined risk
Avoid when:
- Bullish on stock
- Stock breaking out upward
- IV is low
Comparison: Credit Spreads vs. Debit Spreads
| Feature | Debit Spread | Credit Spread |
|---|---|---|
| Entry | Pay money | Receive money |
| Profit when | Stock moves in your direction | Stock stays flat or moves in direction |
| Max gain | Usually ≥ max loss | Usually < max loss |
| Probability | Lower (~40-50%) | Higher (~60-70%) |
| Best for | Directional conviction | Income generation |
| Time decay | Hurts you | Helps you |
| Best IV | Low | High |
Rule of thumb:
Low IV → Buy debit spreads (options are cheap) High IV → Sell credit spreads (collect rich premiums)
Strategy 5: Long Straddle
Overview
Market View: Neutral direction but expect big move (high volatility)
Construction:
- Buy a call (ATM)
- Buy a put (ATM)
- Same strike, same expiration
Risk Profile:
- Maximum loss: Total premium paid
- Maximum gain: Unlimited (upside) or large (downside)
- Breakeven: Two points (strike ± total premium)
Why Use It?
When you expect volatility but don't know direction:
- Before earnings
- Before FDA decisions
- Before elections
- Before major announcements
You profit if the stock makes a BIG move in EITHER direction.
Construction Example
Stock: NFLX at $450, earnings tomorrow
Your Trade:
- Buy 1 NFLX $450 Call @ $18
- Buy 1 NFLX $450 Put @ $17
- Total cost: $18 + $17 = $35 ($3,500 per straddle)
- Expiration: 1 week (to capture earnings)
Position analysis:
Maximum loss: $35 per share = $3,500
- Occurs if stock exactly at $450 at expiration
- Both options worthless
Maximum gain: Unlimited (theoretically)
- Call profits if stock rises significantly
- Put profits if stock falls significantly
Breakeven points:
- Upside: $450 + $35 = $485
- Downside: $450 - $35 = $415
You need stock to move outside the $415-$485 range (7.8% in either direction).
Payoff Diagram
Profit/Loss
+$5,000 | /
| /
+$3,000 | /
| /
+$1,000 | /
| / \
$0|_________/__________\___________ Stock Price
| $415 $450 $485
| (BE) (ATM) (BE)
-$2,000 | |
| |
-$3,500 |______________ Max Loss
|
$400 $425 $450 $475 $500
Outcome Scenarios
Scenario A: Big move up (NFLX at $490)
- Call profit: ($490 - $450) - $18 = $22
- Put loss: -$17 (expires worthless)
- Net: $22 - $17 = $5 per share = $500 profit
Scenario B: Big move down (NFLX at $410)
- Put profit: ($450 - $410) - $17 = $23
- Call loss: -$18 (expires worthless)
- Net: $23 - $18 = $5 per share = $500 profit
Scenario C: Small move (NFLX at $460)
- Call profit: ($460 - $450) - $18 = -$8
- Put loss: -$17 (expires worthless)
- Net: -$25 per share = -$2,500 loss
You were right about direction but wrong about magnitude.
Scenario D: No move (NFLX at $450)
- Both options expire worthless
- Max loss: $35 per share = -$3,500
The Implied Move
Before earnings, you can calculate the implied move from the straddle price:
Formula:
Implied Move = ATM Straddle Price × 0.85
In our example: Straddle cost = $35 Implied move = $35 × 0.85 = $29.75 (about 6.6%)
Market expects NFLX to move ±$29.75 (from $450).
Trading implication:
If you expect move > $29.75: Buy the straddle (market underestimates) If you expect move < $29.75: Sell the straddle (market overestimates)
When to Use Long Straddle
Use when:
- Expecting big move, uncertain of direction
- Catalyst event coming (earnings, FDA, etc.)
- IV is relatively low (cheap straddle)
Avoid when:
- IV is already very high (overpaying)
- Unclear catalyst (why would stock move?)
- Can't afford to lose entire premium
The Biggest Risk: Volatility Crush
Classic scenario:
Before earnings:
- High IV (60%)
- Straddle costs $35
After earnings, stock moved from $450 to $465 (+$15):
- You'd expect profit, right?
- But IV collapsed to 30%
- Call worth $16 (instead of $20+ you expected)
- Put worth $0
- Total value: $16
- Loss: $35 - $16 = -$19 = -$1,900
Even though stock moved $15, you lost money due to volatility crush.
This is why straddles before earnings are so risky. The market prices in the expected move. You need a move LARGER than expected to profit.
Management Tips
1. Exit before expiration
Don't hold straddles to expiration. Exit as soon as you have a profitable move.
2. Close the losing side
If stock moves up, the put is worthless. Close it to reduce risk if stock reverses.
3. Consider time frame
Don't buy 1-day straddles unless extremely confident. Give yourself time (but not so much that premium is huge).
Strategy 6: Long Strangle
Overview
Market View: Expect big move but less certain than straddle (cheaper alternative)
Construction:
- Buy an OTM call
- Buy an OTM put
- Same expiration, different strikes
Risk Profile:
- Maximum loss: Total premium paid (less than straddle)
- Maximum gain: Unlimited (upside) or large (downside)
- Breakeven: Two points (further apart than straddle)
Think of it as: A cheaper straddle that needs an even bigger move to profit.
Construction Example
Stock: TSLA at $250, product announcement in 2 weeks
Your Trade:
- Buy 1 TSLA $270 Call @ $8
- Buy 1 TSLA $230 Put @ $7
- Total cost: $8 + $7 = $15 ($1,500 per strangle)
- Expiration: 3 weeks
Compare to straddle (for reference):
- $250 call @ $15, $250 put @ $14 = $29 total
- Strangle costs about half the straddle
Position analysis:
Maximum loss: $15 per share = $1,500
- Occurs if stock between $230-$270 at expiration
Breakeven points:
- Upside: $270 + $15 = $285
- Downside: $230 - $15 = $215
You need stock outside $215-$285 range (14% move either way).
Payoff Diagram
Profit/Loss
+$4,000 | /
| /
+$2,000 | /
| /
$0|__________/____________\__________ Stock Price
| $215 $230 $270 $285
| (BE) (BE)
-$1,000 | \_________/
| |
-$1,500 |_____________ Max Loss
|
$210 $230 $250 $270 $290
Straddle vs. Strangle Comparison
| Feature | Straddle | Strangle |
|---|---|---|
| Cost | Higher ($29) | Lower ($15) |
| Breakeven | Closer (±$29) | Further (±$35) |
| Max loss | Higher | Lower |
| Move needed | Smaller | Larger |
| Best for | High conviction in volatility | Moderate conviction, want cheaper entry |
Rule of thumb:
Strong volatility conviction → Straddle Moderate volatility conviction → Strangle
When to Use Long Strangle
Use when:
- Expecting significant move (but less certain than straddle)
- Want cheaper entry than straddle
- Can't afford straddle cost
- IV is moderate (not extremely high)
Avoid when:
- IV is very high (even strangles expensive)
- Stock unlikely to make big move
- Same as straddle warnings
Strategy 7: Iron Condor
Overview
Market View: Stock will stay within a range (neutral/sideways)
Construction:
- Sell an OTM call (upper short strike)
- Buy a further OTM call (upper long strike)
- Sell an OTM put (lower short strike)
- Buy a further OTM put (lower long strike)
- Same expiration
This is: Bull put spread + Bear call spread combined
Risk Profile:
- Maximum loss: Spread width - credit received (limited)
- Maximum gain: Net credit received (limited)
- Breakeven: Two points (at short strikes ± credit)
Why Use It?
Perfect for range-bound markets:
- Profit from time decay
- Profit from volatility decrease
- Defined risk (spread widths)
- High probability of profit
Think of it as: Betting stock stays within a range, collecting premium from both sides.
Construction Example
Stock: SPY at $450
Your Trade (Iron Condor):
Call side (bear call spread):
- Sell 1 SPY $460 Call @ $2
- Buy 1 SPY $465 Call @ $1
Put side (bull put spread):
- Sell 1 SPY $440 Put @ $2
- Buy 1 SPY $435 Put @ $1
Net credit: ($2 + $2) - ($1 + $1) = $2 ($200 per iron condor)
Expiration: 30 days
Position analysis:
Maximum gain: $2 per share = $200 per iron condor
- Occurs if SPY stays between $440-$460 at expiration
- All options expire worthless
Maximum loss: Spread width - credit = ($5 - $2) = $3 per share = $300 per iron condor
- Occurs if SPY below $435 or above $465
Breakeven points:
- Upside: $460 + $2 = $462
- Downside: $440 - $2 = $438
Profit zone: SPY stays between $438-$462 (±$12 or ±2.7%)
Risk/Reward: 1.5:1 ($300 risk for $200 gain)
Payoff Diagram
Profit/Loss
+$200 | _____________ Max Gain
| / \
| / \
$0|____/ \________ Stock Price
| $438 $440 $460 $462
| (BE) (Short) (Short) (BE)
|
-$150 | / \
| / \
-$300 |/ \__ Max Loss
|
$435 $445 $450 $455 $465
(Long) (Long)
Why Iron Condors Work
1. Time decay (Theta): All four options decay over time. Since you're net short (sold 2, bought 2), you profit from decay.
2. Volatility decrease (Vega): If IV drops, the options you sold lose value faster than the options you bought.
3. Probability: You win if stock stays in a range. Statistically, stocks stay in ranges more than they break out.
Greeks Profile
Delta: Near zero (neutral position) Gamma: Negative (risky near expiration if stock approaches strikes) Theta: Positive (you collect time decay daily) Vega: Negative (you benefit from IV decrease)
This is a Theta-positive, Vega-negative strategy. You want time to pass and volatility to fall.
When to Use Iron Condor
Use when:
- Expecting low volatility / range-bound market
- IV is high (collecting good premium)
- After volatility events (post-earnings)
- Want high-probability trades
- Time decay is strong (30-45 DTE)
Avoid when:
- High volatility expected
- Stock breaking out/down
- Major catalyst approaching (earnings)
- IV is already very low
Management Tips
1. Take profits early (50% of max gain)
Collected $200 credit, can close for $100? Take it! You've captured half the profit with most of the time remaining.
2. Adjust when tested
If stock approaches one of your short strikes:
- Close the untested side (lock in that profit)
- Roll the tested side (extend time, adjust strikes)
- Take the loss if it's clear you're wrong
3. Size appropriately
Iron condors have limited gains ($200) but can lose more ($300). Use proper position sizing—never risk more than 2-5% of account per trade.
4. Monitor 21 days before expiration
Most Theta decay happens in last 21 days. If you're profitable at 21 DTE, consider closing.
Real Example
April 1: QQQ at $375
Enter iron condor:
Call side:
- Sell $385 call @ $3
- Buy $390 call @ $1.50
Put side:
- Sell $365 put @ $3
- Buy $360 put @ $1.50
Net credit: ($3 + $3) - ($1.50 + $1.50) = $3 ($300)
Max gain: $300 Max loss: ($390 - $385) - $3 = $200 Profit zone: $362-$388 (±3.5%)
April 20 (10 days before expiration): QQQ at $380
Current value:
- $385 call: $1
- $390 call: $0.50
- $365 put: $0.50
- $360 put: $0.20
Spread value: ($1 + $0.50) - ($0.50 + $0.20) = $0.80
Your profit: $3.00 - $0.80 = $2.20 = $220 (73% of max gain)
Decision: Close early. You've captured $220 of the possible $300 with 10 days of risk remaining.
Action:
- Buy to close $385 call @ $1
- Sell to close $390 call @ $0.50
- Buy to close $365 put @ $0.50
- Sell to close $360 put @ $0.20
- Net debit: $0.80
- Profit: $220
Strategy 8: Calendar Spread (Time Spread)
Overview
Market View: Neutral short-term, neutral to directional long-term
Construction:
- Sell a near-term option (front month)
- Buy a longer-term option (back month)
- Same strike (usually ATM)
Risk Profile:
- Maximum loss: Net debit paid (limited)
- Maximum gain: Variable (depends on back month value)
- Profit from time decay differential
Why Use It?
The concept: Short-term options decay faster than long-term options.
You sell a 30-day option (high Theta) and buy a 90-day option (lower Theta). As time passes, you profit from the difference.
Best for:
- Neutral markets
- After high IV events (IV will decrease more for near-term)
- Want to profit from time decay without direction
Construction Example
Stock: AAPL at $180
Your Trade (Call Calendar):
- Sell 1 AAPL $180 Call (30 days) @ $5
- Buy 1 AAPL $180 Call (90 days) @ $9
- Net debit: $9 - $5 = $4 ($400 per calendar)
The plan:
- Near-term call expires (hopefully worthless or small value)
- You keep most of the $5 collected
- Long-term call retains value
- Net profit from decay differential
Outcome at Front Month Expiration
Scenario A: Stock exactly at $180
Ideal scenario:
- Front month $180 call: Expires worthless
- Back month $180 call: Still has 60 days, worth ~$7
- Profit: ($7 + $5 collected) - $9 paid = $3 = $300
Scenario B: Stock at $175
- Front month $180 call: Expires worthless
- Back month $180 call: OTM, worth ~$4-5
- Profit/Loss: Breakeven to small profit
Scenario C: Stock at $190
Not ideal:
- Front month $180 call: You owe $10
- Back month $180 call: Worth ~$14
- Net: ($14 - $10) - $4 = $0 = Breakeven
Big moves hurt calendar spreads!
When to Use Calendar Spread
Use when:
- Expecting low volatility
- Stock range-bound
- After earnings (IV crush helps)
- IV is high (front month has more extrinsic value)
Avoid when:
- Expecting big moves
- High volatility predicted
- Trend is strong
Management Tips
1. Close at front month expiration
Don't let the front month expire and hope. Close both legs together to realize profit.
2. Benefit from IV crush
Enter before earnings on the back month, sell front month after earnings. The IV differential works in your favor.
3. Roll if needed
If approaching expiration with profit, consider rolling front month to next cycle.
Strategy 9: Diagonal Spread
Overview
Market View: Directional but patient (combines vertical + horizontal)
Construction:
- Sell a near-term option (closer strike)
- Buy a longer-term option (further strike)
- Different strikes AND different expirations
Risk Profile:
- Maximum loss: Net debit paid (limited)
- Maximum gain: Variable but substantial
- Profit from both direction and time decay
Think of it as: A calendar spread with a directional bias.
Construction Example
Stock: MSFT at $380, mildly bullish
Your Trade (Bullish Diagonal):
- Sell 1 MSFT $390 Call (30 days) @ $3
- Buy 1 MSFT $380 Call (90 days) @ $15
- Net debit: $15 - $3 = $12 ($1,200 per diagonal)
The plan:
- Stock rises slowly to $390
- Near-term call expires/closes for small loss
- Roll to next month, collect more premium
- Long-term call gains from stock appreciation
- Repeat monthly for income
Why Diagonals Are Powerful
1. Directional exposure (long call benefits from rise) 2. Income generation (short call collects premium) 3. Time decay advantage (short-term decays faster) 4. Flexibility (can roll short call monthly)
This is sometimes called "poor man's covered call"—similar mechanics but with far less capital.
Management
1. Roll the short call monthly
Every 30 days, close the short call and sell next month's call, collecting more premium.
2. Adjust strikes as stock moves
If stock rises to $390, next month sell the $400 call instead.
3. Close for profit
If long call appreciates significantly and short call is small, consider closing entire position.
Key Takeaways
Before moving to Module 7, ensure you understand:
✓ Spreads combine multiple options to define risk/reward precisely
✓ Vertical spreads (same expiration, different strikes) are directional with limited risk
✓ Debit spreads: Pay upfront, profit from movement (low IV)
✓ Credit spreads: Collect upfront, profit from time decay (high IV)
✓ Straddles/strangles profit from big moves in either direction
✓ Iron condors profit from range-bound markets and time decay
✓ Calendar spreads profit from time decay differential
✓ Diagonal spreads combine directional bias with income generation
✓ IV environment determines strategy selection (high IV = sell, low IV = buy)
✓ Exit most spreads at 50-75% of max profit—don't be greedy
✓ Position sizing is critical—limited gains mean you need multiple positions to build wealth
Self-Check Questions
Test your understanding:
-
You enter a bull call spread for $5 debit with strikes $100/$110. What's your maximum gain?
Click to reveal answer
Maximum gain = Spread width - debit paid = ($110 - $100) - $5 = $5 per share = $500 per spread. This occurs if stock is above $110 at expiration.
-
Which spread should you use in a high IV environment: debit spread or credit spread?
Click to reveal answer
Credit spread. High IV means options are expensive. Selling them (credit spreads) allows you to collect rich premiums. You want to be a net seller when IV is high.
-
You enter an iron condor collecting $3 credit with $5 spread widths. What's your maximum loss?
Click to reveal answer
Maximum loss = Spread width - credit received = $5 - $3 = $2 per share = $200 per iron condor. This occurs if the stock moves beyond either spread at expiration.
-
A stock at $100 has an ATM straddle costing $8. What's the approximate implied move?
Click to reveal answer
Implied move ≈ Straddle price × 0.85 = $8 × 0.85 = $6.80 (±6.8%). The market expects the stock to move about $6.80 in either direction.
-
When should you consider closing a profitable credit spread early?
Click to reveal answer
At 50-75% of maximum profit. If you collected $200 and can buy it back for $50-100, close it. You've captured most of the profit and free up capital/reduce risk.
Practice Exercise: Strategy Selection
For each scenario, select the most appropriate intermediate strategy:
Scenario 1: SPY at $450. You think it'll stay between $440-$460 for the next month. IV Rank is 70%.
Scenario 2: AAPL at $180. You're moderately bullish, expecting $190 in 6 weeks. IV Rank is 30%.
Scenario 3: TSLA reports earnings tomorrow. Currently at $250. You expect a massive move but unsure which direction. IV Rank is 95%.
Scenario 4: NVDA at $500. You're neutral to slightly bullish and want to collect income monthly with defined risk.
Scenario 5: AMZN at $175. You think it'll fall to $160 over the next month but want cheaper entry than buying puts. IV Rank is 25%.
Solutions:
Click to reveal detailed solutions
Scenario 1: Iron Condor
Why:
- Range-bound expectation ($440-$460)
- High IV (70%) means rich premium to collect
- Want to profit from stock staying within range
Setup:
- Sell $460/$465 call spread
- Sell $440/$435 put spread
- Collect premium, profit if SPY stays in range
Scenario 2: Bull Call Spread
Why:
- Moderately bullish (not expecting huge move)
- Low IV (30%) means options are cheap (good for buying)
- Debit spread is cost-effective directional play
Setup:
- Buy $180 call
- Sell $190 call
- Pay small debit, profit if AAPL reaches $190
Alternative: Could also do bull put spread (neutral to bullish), but since IV is low, debit spread is better.
Scenario 3: Avoid / Or Long Straddle if confident
Why:
- IV Rank 95% means options are extremely expensive
- Volatility crush after earnings will be severe
- Even if right about big move, IV collapse could cause losses
If forced to trade:
- Long straddle or strangle (betting move exceeds implied move)
- But this is very risky
Best advice: Wait until after earnings when IV collapses, then trade.
Scenario 4: Diagonal Spread (Poor Man's Covered Call)
Why:
- Want income generation (short calls)
- Want defined risk (not naked calls)
- Neutral to slightly bullish (directional component)
Setup:
- Buy $500 call (90 days)
- Sell $510 call (30 days)
- Collect premium monthly, roll short call
Alternative: Bull put spread (collect premium, bullish bias).
Scenario 5: Bear Put Spread
Why:
- Bearish directional view
- Low IV (25%) means options are cheap (good for buying)
- Want cheaper entry than long put alone
Setup:
- Buy $175 put
- Sell $160 put
- Pay moderate debit, profit if AMZN falls to $160
Comparison to long put:
- Long put costs more but has unlimited downside profit potential
- Bear put spread costs less but caps profit at $160
- Since target is $160, bear put spread is perfect
What's Next?
Congratulations! You've now learned the intermediate strategies that professional traders use daily. You understand:
- How to reduce costs with spreads
- How to profit from time decay
- How to profit in neutral/range-bound markets
- How to profit from volatility changes
- How to select strategies based on IV environment
These tools give you tremendous flexibility. You're no longer limited to "stock goes up = profit" or "stock goes down = profit." You can now express nuanced views and construct positions for virtually any market outlook.
In Module 7: Risk Management, we'll focus on the most important aspect of trading: protecting your capital. You'll learn:
- Position sizing principles
- Stop loss strategies
- Portfolio construction
- Common mistakes and how to avoid them
- The psychology of risk management
Strategy knowledge is worthless without risk management. The best traders aren't those with the highest win rates—they're those who manage risk masterfully.
Ready to continue? Proceed to Module 7: Risk Management