Options strategies continue to prove attractive to various investors in a complex market environment. For those investors with a strong foundational understanding of options, a multi-leg options strategy may afford more nuanced opportunities than single options positions.
A multi-leg options order occurs when more than one option contract is purchased or sold together as a single trade. These orders make up a singular strategy and are used to pursue investment goals that include income generation, hedging, or future price speculation of a stock. They include using option contracts with various strike prices, expiration dates, or sensitivities to the underlying asset’s price movement.
Considered complex options strategies for advanced traders, multi-leg options orders offer a more nuanced take on options trading. Multi-leg options strategies carry a different risk profile than a single options position but still include the use of calls and/or puts. Commonly used multi-leg options strategies include spreads, straddles, and collars.
A call option gives the buyer the right, but not the obligation, to buy a stock at an agreed strike price. Calls are generally used to express the buyer’s bullish sentiment. A put option gives the buyer the right, but not the obligation, to sell a stock at an agreed strike price. Puts generally express the purchaser’s bearish sentiment.
Multi-Leg Options Spreads
The most frequently used spreads by investors include bull call spreads, bear put spreads, and butterfly spreads. A bull call spread entails trading two calls — a long call at a lower strike price and a short call at a higher strike price — on the same underlying asset. Investors use it when they expect prices to rise toward the higher strike price position or to surpass it. Profits for a bull call strategy are limited to the difference between the strike prices of the short and long options used minus the net premium paid. It allows for a lower breakeven point compared to a single long call position.
A bear put spread works similarly to a hedged strategy but with the use of a short put and a long put. It’s designed to profit on falling prices, with profits limited to the difference between the strike prices of the long and short options used minus the net premium paid. It also allows for a reduced breakeven point compared to a single long put position.
A butterfly spread combines bull and bear spreads, using four (or more) options contracts. These options all have different strike prices but share the same expiration date. The strike prices include an at-the-money strike price and both a higher and lower strike price equidistant from the at-the-money strike price. Butterfly spreads can use any combination of puts and calls to create long or short butterfly spreads.
Straddles and Strangles
Meanwhile, a straddle entails trading a long call and put at the same strike price with the same expiration. A long straddle is a directionally neutral strategy that uses a long call and put with the same strike price and expiration. It relies on price momentum changes to generate returns. This means the underlying price can rise or fall and would still make a profit for a long straddle if the price moved a large-enough degree. A short straddle uses a short call and put at the same strike price and expiration. It benefits when the underlying asset remains range-bound.
A strangle is similar to a spread but with a different risk profile. A long strangle buys a call and a put option with different strike prices but the same expiration. It benefits when prices move beyond either strike price. A long strangle has greater risk than a long spread; should the underlying price expire within the range of the strike prices, it results in a loss for the buyer. A short strangle sells a call and a put option with different strike prices and the same expiration but benefits when prices remain range-bound.
Collar Strategies
A collar strategy provides a hedge against significant drawdown and volatility but also limits upside returns. Collar strategies entail holding the underlying asset, buying an out-of-the-money put option, and selling an out-of-the-money call option. The put option protects against losses beyond the strike price, while the call option generates a premium that is used to help fund the put purchase.
Those who invest in collar strategies receive the highest profit when the asset’s price rises but doesn’t surpass the strike price. Collar strategies are generally used by those who are bullish on the long-term outlook for a stock but may be concerned about short-term volatility or downturn. It’s also an attractive strategy for more conservative investors looking to preserve their gains. These investors may not mind trading upside potential for downside protection.
Multi-leg options provide a variety of potential positions and strategies, offering nuance and opportunity beyond single-leg positions. Whether seeking income, hedging volatility or drawdown, or speculating on price movements, multi-leg option orders are worth consideration for experienced investors.
Options are not suitable for all investors. Investing in options carries substantial risk and tax consequences. Investors may realize losses on any investments made utilizing leverage. Future returns are not guaranteed, and use of leverage may magnify trading losses.
This article is prepared as a general source of information and is not intended to provide legal, investment, accounting or tax advice, and should not be relied upon in that regard. If legal or investment advice or other professional assistance is needed, the services of a competent professional should be obtained. Information contained in this article does not constitute and shall not be deemed to constitute advice, an offer to sell/ purchase or as an invitation or solicitation to do so for any entity. The content of this article is based on sources believed to be reliable, but its accuracy cannot be guaranteed. BMO InvestorLine Inc. and its affiliates, sponsors and employees do not accept responsibility for the content and makes no representation as to the accuracy, completeness or reliability of the content and hereby disclaims any liability with regards to the same. Any strategies discussed, including examples using actual securities, quotes and price data, are strictly for illustrative and educational purposes only and are subject to change without notice. BMO InvestorLine Inc. is not responsible for the information provided and disclaims all liability with regards to the same.
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