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It is a variation of the ratio spread and is used when the trader believes the asset will make a mild bullish move, and the staggered nature of the short call strike prices prevents the trader from incurring a very large loss if the asset makes a remarkable move to the upside.

The long jelly roll is an options trade that aims to profit from a time value spread through the sale and purchase of two call and two put options, each with different expiration dates.

This type of options can be used in periodic payment situations or balloon payment situations.

Bond options can be traded using calls and puts, and can be traded just as stocks are traded on the options market.

The Black's Model was developed by one of the originators of the Black-Scholes Model, and was created as a variation of the Black-Scholes model to be able to allot a value to futures contracts.

Gamma is used as a measure of the inherent volatility of an asset. A very volatile option contract implies a large gamma. A small gamma therefore implies an asset with low inherent volatility.

The Black's Model was developed by one of the originators of the Black-Scholes Model, and was created as a variation of the Black-Scholes model to be able to allot a value to futures contracts.

The Black-Scholes option pricing model is an example of a gamma pricing model which is usually applied to a stock option to determine its value, using the price variation of the stock, the time value of money, the strike price and expiry time of the option and the time value.

Binary options are also called fixed return options because the payout is fixed, and also called "all or none" options because the trader either receives all the money being paid out for a correct trade, or none of the money paid out if the chosen result is wrong.

Bermuda options are used in both American and European options. They are cheaper to trade than American options for options buyers because the premiums are lower, while they are more flexible than European options for options sellers.

This is used as a hedging strategy. As an example, if a trader purchased an average price put contract of 1,000 barrels of crude when the product is $70 with a view to benefit from falling prices, and the price on expiration is $63, then the average price put payout will be ($70 - $63) X 1,000 barrels = $7,000 (less commissions payable on the trade. If the price on expiration was say $73, then the payout for the trade is zero.

This options greek is used to determine how closely an options contract tracks its underlying market, hence is useful for traders who want to track gamma hedged trades.

Options and commodities are examples of assets where the zero sum game principle is seen. This means that profits made are paid for by losses of counterparties to the profitable trade.

This is used to setup several options trades simultaneously so that the premiums from the net credit trades cancel out the premiums paid on the net debit trades, thus allowing profits to be strictly determined by the asset performance.

Weather conditions such as hurricanes and drought can radically affect the supply of agricultural and energy commodities. These assets are therefore suitable candidates for employing weather derivative protection.

Hi everyone, Nice to see such an active forum. I'm an Options trader (expert level), and looking forward to interacting with fellow traders. If any of you have questions on Options, please feel free to get in touch with me. Best Hari Swaminathan - OptionTiger

An underwater option has a high chance of expiring worthless.

Shareholders are naturally concerned as the date of an earnings report for their favorite stock draws near. Stocks often experience their biggest declines in price after an earnings report fails to meet the expectations of investors. The recent price action in Apple Inc (AAPL) is a perfect illustration. This widely held stock lost more than 12% of its value following its most recent report. Now that many stocks have weekly options, there are new strategies available for earnings report protection. Weekly options can provide low-cost, short-term insurance to lock in a minimum sale price of a stock that is potentially vulnerable to an earnings setback. It has always been possible to use monthly put options to protect the price of a stock through the date of the company’s earnings report. The problem with monthly puts is that they can be quite expensive, particularly when the options expiration date is substantially later than the earnings report. Weekly options are cheaper and offer more flexibility in providing short-term protection. Not all stocks have weekly options, but when they are available, it is prudent to know how to employ them to circumvent an earnings report disaster. There is a cheap but effective strategy to protect the stock price through its earnings report by using a combination of weekly options. It is easiest to present this protective strategy as a combination of two separate trades. The first trade is the purchase of a weekly put option that expires on the closest Friday following the earnings report. For every 100 shares of stock, buy one contract with a strike price that is slightly below the current stock price. While this short-term, protective put provides for a minimum sale price of the stock, it may still seem relatively expensive because option prices often inflate ahead of an earnings report. A second trade is implemented to lower the cost basis of the protective put. The second trade uses weekly options that expire one week prior to the expiration date of the protective put. For every 100 shares of stock, sell one call contract with a strike price above the current stock price. Also sell an equal number of put contracts with a strike price that is one strike below that of the protective put. The premium received from the sale of these options will substantially lower the cost basis of the protective put. It is typically best to do these two trades about two weeks prior to the earnings report date. It is important to understand what has been achieved with these trades. The long stock together with the short call represents a covered call position. The long protective put together the short put represents a diagonal time spread. There is no margin requirement associated with either of these positions. Since the stock price tends to remain in a relatively narrow range prior to the earnings date, it is expected that both of the short options will expire worthless on the Friday prior to the earnings report date. This leaves the protective put in place for full effect through the following week. If the stock price falls significantly after the earnings report, there are two alternatives available to the shareholder. For those who are no longer interested in owning the stock, it can be liquidated at the strike price associated with the protective put. Some shareholders may want to maintain their stock position even after a pull back in price, in which case the protective put can be sold for a profit to offset most of the lost value in the stock. If the stock price soars after the report, the protective put will expire worthless, but there is no cap on the profit that can be achieved by the stock. Some comments are in order regarding the unexpected cases in which the stock price will have moved sufficiently (up or down) during the week before the earnings report that one of the short options will be in-the-money as its expiration date arrives. If the stock price is above the strike price of the short call, the shareholder can either buy back the short call and wait for the earning report or allow the stock to be called away for a profit. If the stock price is below the strike price of the short put, the short call will expire worthless and the diagonal put spread can be sold for a profit. In this latter case, the stock will no longer be protected through the earnings report. Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education and trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.

For those of you who have been following the Facebook (FB) trade that was proposed in my blog entry of 8/15/12, the residual option position is now showing a profit of 76%. Since the residual position includes the long Jan 16 call that will be expiring this Friday (1/18/13), a decision needs to be made. The basic choices are: (i) sell the Jan 16 call and collect the profit, (ii) exercise the call to become the owner of 100 shares of FB stock at a price of $16 per share. (iii) roll the Jan 16 call into a later month. If you wish to continue participating in the price movement of FB, choice (iii) provides that opportunity without the need for extra capital to purchase the stock. Even after choosing (iii), there are further selections to be made in terms of which expiration month and which strike price should be used. Rolling the Jan 16 call into a June call option will provide for another five months of participation in the FB price movement. Here are a couple of possibilities involving June options : (iii-a) Roll the Jan 16 call into the Jun 17 call for a small profit that will cover your commission costs. The Jun 17 call has a delta of 0.96, which means that this option will capture essentially all of the price movement of the stock. (iii-b) Roll the Jan 16 call into the Jun 23 call, which will produce enough profit to cover the cost of your Jan 16 call and thus represents a free trade for the next five months. The Jun 23 call has a delta of 0.83, which will also mimic the price movement of the stock quite well. Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.

Dr. Edward Olmstead, Professor, Northwestern University Chief Options Strategist, Dr. Olmstead’s Options Trading Strategies We've all experienced the situation in which we buy a stock only to see it undergo a significant pullback in price. We still like the stock and feel that it will recover at least some of the ground that it lost. There is a low-cost option strategy that can help you get back to a break-even status when the stock regains only part of its lost value. Holders of Facebook (FB) stock and those who are under water with Apple (AAPL) may find this strategy useful. The stock repair strategy uses options to assist in bringing your stock investment back to a break-even level. This strategy is structured to attain the break-even status at a stock price that is significantly lower than the original purchase price. The great appeal of this strategy is that it involves no additional risk since it can be applied for little or no additional expense. Note that to do the stock repair strategy for little or no cost, it typically requires options with at least two months until expiration. The more time allowed, the more likely a credit will be generated. Stock Repair Strategy For this strategy to work, it is necessary for your fallen stock to make at least a partial recovery. The stock repair strategy uses options to expand that partial recovery into a full recovery of your original investment, with little or no additional expense. If the stock price remains unchanged or continues to fall, this strategy offers no help. The basic plan is to buy one at-the-money call for each 100 shares of stock that you own. You are going to pay for this one long call by selling two out-of-the money calls with the same expiration date. The idea is to use the cash received from the two short calls to pay for the one long call. Choose an expiration month for the options that is far enough out in time for the price of your stock to recover back to the strike price of the short calls. Let's look at some examples to illustrate the stock repair strategy: ‑ Example 1. You bought 100 shares of XYZ back in December when it was $35. You watched it initially go up, but then *undergo a dramatic slide to its current price in early March of $23. You still like the stock and feel that there is some hope for a recovery, although getting back to break-even at $35 seems far away. Let's see how stock repair might help. ‑ Trade: Buy 1 Jun 25 call for $3.30 per share and sell 2 Jun 30 calls for $1.75 per share. This actually produces a net credit of $.20 per share [(1.75 ¥ 2) - 3.3 = .20]. Position: Along with an extra $.20 per share in your account, you hold the combination of a covered call (long 100 shares XYZ and short 1 Jun 30 call) and a bull call spread (long 1 Jun 25 call and short 1 Jun 30 call). See Figure. 16-1 for a risk graph that depicts this position. Payoff: If XYZ is above $30 at the June options expiration, the stock will be called away at $30 per share, for a $7 per share gain over its present price of $23. The bull call spread will be worth $5 per share. The total gain (including the $.20 credit received) is $12.20 per share [7.0 + 5.0 + .2 = 12.2], which is equivalent to a stock price of $35.20. Thus, you will have reached slightly better than break-even, although the stock is still as much as $5 below your original purchase price. ‑ Example 2. You bought 100 shares of YZX back in December when it was $19.50. Now in early March the stock is down 15 percent with a slide to $16.50. Let's see how stock repair can get you back to slightly better than break-even in only 10 weeks with the stock recovering just 6 percent from its *current level. Trade: Buy 1 May 15 call for $2.40 per share and sell 2 May 17.5 calls for $1.10 per share. This does require a small cash outlay, specifically $.20 per share [(1.1 ¥ 2) - 2.4 = -.2]. Position: It has cost you an extra $.20 per share to hold the combination of a covered call (long 100 shares of YZX and short 1 May 17.5 call) and a bull call spread (long 1 May 15 call and short 1 May 17.5 call). Payoff: If YZX is up by only 6 percent from its current level to $17.50 at the May options expiration, you will be slightly better than break-even. The stock will be called away at $17.50 per share for a $1 per share gain over its present price of $16.50. The bull call spread will be worth $2.50 per share. Allowing for the small extra cost to establish this trade, the net gain is $3.30 per share [1.0 + 2.5 - .2 = 3.3], which is equivalent to a stock price of $19.80. Thus, you have reached slightly better than break-even with the stock recovering less than half of its loss. In comparing Examples 1 and 2, note that the stock repair for 1 was done for a small credit, whereas 2 required a small debit. The explanation for this is the amount of time until the options expire (June versus May). Reminder: to do the stock repair strategy for little or no cost, it typically requires options with at least two months until expiration. The more time allowed, the more likely a credit will be generated. Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.

Dr. Edward Olmstead, Professor, Northwestern University Chief Options Strategist, Dr. Olmstead’s Options Trading Strategies We recognize that when it comes to trading options, there's a lot of information to absorb and most people may not have the time to review every detail, so we put together a "cheat sheet" to help you get started. Should you want to explore any or all of these points further, more detail for each item on the check list is provided in our options blog. Following each of these steps does not guarantee a successful trade, but it reduces the risk of a bad trade and that can make a big difference in your overall trading record. Ten Things to Consider BEFORE You Buy an Option 1. Determine how much of your total investment funds you are willing to use for the high-risk trading of options. Once you have determined an appropriate amount for your options trading capital, allocate only about 15% of that capital per option trade. 2. Make sure you are using an options friendly broker. The trading platform for your account should display option prices in real time and easily allow you to execute a trade when the time is right. Live help should be readily available when you need it. Commissions should not be excessive. 3. Anticipate events that might impact the price action of the stock associated with your option. Check on upcoming earnings release dates, FDA decisions, court rulings, ex-dividend dates, etc. Such events can even be the basis for timing an option trade. 4. Review price trends, not only for your stock of interest, but also for the industry that includes your stock, as well as for the overall market. The cliché "The trend is your friend" is good advice in trading options. The more trends going your way, the better are your chances of success. 5. Select an option that gives you the best opportunity for a successful trade. The cheapest option is rarely the best choice. Choose an option with an expiration date that gives the underlying stock ample time to make the expected move in price. Keep in mind that in options trading, time is money. 6. Learn how to enter an option trade at the best available price. Follow options prices in real time, and enter a limit order that is most likely to be filled. Avoid market orders. 7. Set up a scheme to track your option trade with daily entries in a spreadsheet. It is important to develop a feel for how an option price changes in response to changes in the stock price and the passage of time. 8. Have an exit plan for profit. Decide on a reasonable move in the stock price for a suitable profit to be achieved in the option. The amount of profit will depend on how quickly the stock price reaches the desired level. If the profit comes quickly, you might consider holding on for a bigger gain, but remember that options are time limited. Don't be greedy. 9. Have an exit plan to limit loss. Identify a stock price level that suggests a failure of the move that had been anticipated. When the stock price reaches the failure level, exit the trade to limit loss. Not all option trades will be winners, so it's important to exit a losing trade early and preserve capital for future trades. 10. Gain access to a program that includes an options calculator or risk graph display. Having an unbiased source to check the profit and loss characteristics for your trade is a valuable tool. Some brokers provide such a tool on their trading platform. Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.

Options are a high-risk investment, but they are also highly profitable. Traders enter the option market for many reasons. One reason is because the amount of capital required to enter the market is lower than regular stock. The fact that most options move faster (volume) and produce higher returns is another reason traders dabble in the option market. Many brokerage houses limit the amount of cash (margin) new traders can use to invest because of the market's high potential for loss. As option traders become experts, these limitations go away, and the trader is free to invest as much as their account allows. Once a new trader gets familiar with how the option market works, they can become an expert in no time at all. Stock vs. Option Regular or preferred stock is an asset. In other words, stock is equity, and it gives the holder ownership in the company where it's drawn from. It trades easy in the exchange because, like money, investors consider it a liquid asset. An option is a derivative of stock. This means that its value completely depends on the value of the equity associated with it. Option Buyers: Option buyers own a contract that says they have the right to buy or sell an asset by a certain date (expiration date). Option buyers are not obligated to buy or sell the asset, and if they choose not to, they let their option expire as it becomes worthless. Option Sellers: Option sellers own a contract that obligates them to buy or sell an asset by a certain date (expiration date), if the buyer excercises the option. Most option sellers hope the buyer's contract expires, so they can collect premiums. Online Brokers Most investors trade options using an online broker system that connects directly to the brokerage house holding trader's investment account. Traders send orders through their broker, which go directly to an exchange. Their brokerage house, which has a seat on the exchange floor, receives the investor's order and sends the trader's request to auction after deducting or adding funds to their investment account. All this takes place in real-time, which occurs in a matter of seconds. Expiration Every option expires. Traders call an option's expiration date, the strike date, because it stands as a marker where all options must be either be bought or sold. On or before the strike date, the trader can either choose to exercise the option and buy the underlying asset, or they can let the option expire, where its value then becomes worthless. Strike Price, Exercise & Assignment An option's strike price is the value an investor will pay to exercise their right to buy or sell the option. If a buyer chooses to exercise the option, the brokerage house assigns the seller's assets to the buyer's account. Margin Requirements Margin is the total amount in which an investor can use to make a trade. Most traders make a deposit at a brokerage house, which serves as collateral for buying and selling options. Normally, the trader can only buy or sell options up to the balance available in their account (margin). Sometimes, brokerage firms extend credit to the trader, which adds on to their margin's limit. However, if at any time a trader buys an option on credit (borrowed margin), makes a bad choice, and their option starts to lose value, the brokerage house has the right to immediately sell the option to cover the margin (margin call). Order Entry Home broker systems basically have two types of transactions, buy and sell. Investors can fine-tune their orders by adding details to the order, including limit, stop or market, which directs their broker on how to specifically auction it. Types of orders In each of the two types of order entries, there are two types of orders that a trader can place. Call Orders Buying a call option - Trader buys a call option thinking its price will go up (long-buying). Buying the underlying asset is not an obligation. Selling a call option - Trader sells (writes) a call option thinking its price will go down (short-selling). Trader must sell the underlying asset, if a buyer exercises the option. Put Orders Buying a put option - Trader buys a call option thinking its price will go down. Selling the underlying asset is not an obligation. Selling a put option - Trader buys a call option thinking its price will go up. Trader must buy the underlying asset, if a buyer exercises the option. Moneyness Moneyness is the real value of an option. An option starts to lose value the minute it enters the market. The closer it gets to its expiration date, the less it's worth. Investors call this occurrence time decay. Intrinsic value is simply the difference between an option's strike price and the underlying asset's market price. Option traders calculate moneyness by adding an option's intrinsic value to its time decay value. NEXT: [thread=11548]Call Option[/thread]

An uncovered put write, or a "naked put" as it is frequently called by investors, is an investing strategy which is fundamentally a bet on a stock either staying near its current price or going up. The put in this case is called uncovered because the put writer does not own the underlying stock. Instead, the option trader simply writes put contracts at a strike price and collects the premium. If the stock price stays at or above the strike price to expiration, then the trader collects the premium as profit. However, if the price falls below the strike price, then losses are unlimited (except for the premium) until the stock price reaches zero. To see how this works (see diagram) suppose stock XYZ is trading at $45 and the trader writes 1 uncovered put contract at a strike price of $45 for a premium of $2. This would cost $200 for a contract (1 contract=100 shares). If the stock price goes up or stays at $45 all the way to the option expiration date, the trader keeps the premium ($200) as the maximum profit. However, if the price falls below the strike price, then losses depend on the expiration price. For example, if the price at expiration is $40 then the loss would be $5 per share or $500 minus the premium price of $200 for a total loss of $300. Maximum loss would be if the stock price went to $0 which would be $45 per share or $4500 (minus the premium collected). When to use uncovered puts The best time to use uncovered puts is in periods of low volatility for a stock. If the trader feels there will be little price change in a stock over time, then uncovered puts are a valid strategy. Some traders use these instruments as a major source of income, collecting premiums from expired contracts month-after-month. However, uncovered puts do carry with them a high amount of downside risk if the price of a stock goes down rapidly. Therefore, it is best not to write uncovered puts before an earnings report, expected news release, or any other known factor that could rapidly move the stock price. There is also the risk that if the put is held to expiration, the put will be executed and the put writer will have to take delivery of the stock. The stock could then continue its decline and increase losses. Because of factors such as these, many brokers will not allow traders to write uncovered puts without a substantial amount of capital to serve as security in case of loss. Types of stocks that work well with uncovered puts The type of stocks that work well with the uncovered put strategy tend to be large, blue chip type stocks that have low volatility and a stable, long-term price trend. It is also wise to choose stocks such as these that are: (1) on a relative uptrend in terms of revenues and earnings or (2) have just been through a strong selloff as a way to hedge against any unforeseen downside price movement.

Traders who implement a synthetic long stock strategy are betting that the market price for an option's underlying asset will go up. The technique involves buying call options and writing (selling) an equal amount of put options for the same underlying asset. Traders who use this method enter the market at low-to-zero cost. Both the potential profit and the potential loss are unlimited when entering this type of synthetic position. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important when considering the risks involved when implementing a synthetic long stock strategy. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Synthetic Long Stock Strategy (ATM) XYZ is worth $40 (market price) 1) Trader writes (sells) a put option: XYZJan40($1) - 100 shares of XYZ stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $1 2) Trader buys a call option: XYZJan40($1.50) - 100 shares of XYZ stock - Strike Price $40 (ATM), expiring in 30 days - Premium Cost of $1.50 3) Trader pays a total of $50 in premiums to enter the market [$150 (paid for call) - $100 (received from put)] Result one: XYZ hits $50 a) The put option expires worthless (OTM). b) The call option is ITM. The trader exercises his or her right to buy 100 shares at $40, pays $4000 to the writer, and immediately sells the shares in the open market for $5000. c) The trader makes a total profit of $950 after subtracting the premiums paid to enter the market. [$950 = $1000 (profit from call) - $50 (cost to enter market)] Result two: XYZ hits $30 a) The call option expires worthless (OTM). b) The put option is ITM. The put buyer exercises his or her right to sell 100 shares at $40. The trader pays $4000 to the put buyer and sells the 100 shares received from the buyer in the open market for $3000. c) The trader loses a total of $1050 after adding the cost to enter the market. [$1050 = $1000 (loss from put) + $50 (cost to enter market)] Advantage and Disadvantage of Implementing a Synthetic Long Stock: Pluses: The upside to this type of strategy is that the investor can make unlimited profits in a bull market, since the potential growth of any underlying asset is infinite. Another advantage to this technique is that the investor can enter the market at a very low cost. Minuses: The downside in using a synthetic long stock strategy is when the underlying asset's market value falls. When this happens, the trader's loss risk becomes unlimited, as an asset's market price can decline to a zero value.

Traders who implement a covered straddle strategy are betting that the market price will go up for the assets owned in their portfolio. The technique involves writing (selling) the same amount call and put options for owned shares. Traders gain limited premiums when the market rises, but they expose themselves to unlimited loss risk when the market value of the option's underlying asset falls. The covered straddle strategy is similar to placing two covered calls. The Differences Between ITM, ATM and OTM for Puts and Calls There are five ways to define the relationship between an option's strike price and the market price of its underlying asset for puts and calls. Understanding the differences between the terms is important because of the risks involved in when the market declines and when assigning assets. Put Options: ITM - In The Money: The underlying asset's market price is less than option's strike price. OTM - Out of The Money: The underlying asset's market price is more than option's strike price. Call Options: ITM - In The Money: The underlying asset's market price is more than option's strike price. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Both Put and Call Options: ATM - At The Money: The underlying asset's market price equals the option's strike price. How to Implement a Covered Straddle Strategy (ATM) XYZ is worth $54 (market price) 1) Trader buys 100 shares of XYZ preferred stock and pays $5400. 2) Trader writes (sells) a put option: XYZJan55($3) - 100 shares of XYZ stock - Strike Price $55 (ATM), expiring in 30 days - Premium Cost of $3 3) Trader writes (sells) a call option: XYZJan55($4) - 100 shares of XYZ stock - Strike Price $55 (ATM), expiring in 30 days - Premium Cost of $4 4) Trader receives $700 in premiums ($300 from put + $400 from call) Total Investment cost: $4700 [$5400 (paid) - $700 (premiums collected)] Result one: XYZ hits $57 a) The put option expires worthless (OTM), and the trader keeps the $300 in premiums. b) The call option is ITM. The call buyer exercises his or her right to buy the seller's 100 shares at $55, paying $5500 to the seller. c) The trader makes $800 after subtracting the amount received from the call option from the total cost of investment. [$800 = $5500 (call sale) - $4700 (cost of investment)] Result two: XYZ hits $45 a) The call option expires worthless (OTM), and the trader keeps the $400 in premiums. b) The put option is ITM. The put buyer exercises his or her right to sell 100 shares at $55. The writer sells his 100 shares in the open market receiving $4500 and adds $1000 out of his or her pocket to pay $5500 to the put buyer. c) The 100 shares received from the buyer suffer a $200 paper loss. [$4500 (current market value) - $4700 (cost of investment)] d) The trader loses a total of $1200 after adding the amount paid out-of-pocket to the paper loss on shares owned. [$1200 = $1000 (paid out-of-pocket) - $200 (paper loss)] Advantage and Disadvantage of Implementing a Covered Straddle Strategy: Pluses: The upside to this type of strategy is that the investor will always make a limited profit in a bull market. Another advantage in using a covered straddle strategy is that the premiums collected give the trader a discount on the total cost of the investment. Minuses: The downside in using a covered straddle strategy is that the method limits an investor's profits. Also, if the underlying asset's market value falls, the trader's risk becomes unlimited, as an asset's price can decline to a zero value.