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Probably the best thing about being options trader is the incredible flexibility we have when combining them to form new risk profiles. Options can also be combined in varying amounts to increase or decrease the steepness of the profit and loss graphs. Using the popular straddle strategy as a base, we will show how various combinations can create a more directional bias with a protective feature.

For instance, the options strategist can employ a ratio type strategy where the trader buys one call and two puts with the same strike and expiration dates. This particular combination of long calls and puts is similar to a long straddle. However, because they are done in different proportions, one call and two puts, the slope of the profit and loss lines will be a bit different.

By employing this strategy the trader will profit more from a fall in the stock as compared to a rise. If the options strategist is uncertain about the direction but leaning a little toward the downside, this type of ratio straddle could be a perfect fit. The tradeoff, of course, is that this ratio straddle costs more than the straddle because the trader is buying an additional put.

Due to this additional cost, a bigger rise in the stock will be necessary before breakeven is achieved to the upside as compared to the straddle. Conversely, this particular ratio straddle will show a profit quicker as compared to the straddle if the stock should fall. Both strategies hit maximum loss at the strike price, because all options will expire worthless.

Another type of ratio straddle is where the trader buys two calls but only one put. In this case the options strategist is uncertain about direction but is anticipating a higher probability the stock will rise. If the stock rises, this strategy will profit at a faster pace. However, if the stock falls the trader will still profit but will have a much lower breakeven point as compared to the straddle. Again, both strategies realize their maximum loss at the strike price, because all options will expire worthless.

Another variation involves adjusting the traditional straddle to reflect a slight bias toward one direction or another. While straddles are used when unsure of direction, most people have some opinion if they had to guess. If so, the trader may want to stack the odds a little in favor of that direction.

For example, if the stock is trading for $50 and we are more bullish than bearish, we may want to use the $45 straddle, thus putting the call in-the-money [ITM]. This makes the straddle a little more responsive to upside moves in the stock and is called a bull straddle. The same thing can be done on the bearish side by having the put in-the-money [ITM].

These strategies should suggest how powerful options can be. Not only can you build your profit and loss profile in the direction you want, but you can also adjust the rates of profit and losses. In addition, there is no reason to stop here. An options strategist could easily buy three puts for every one call or three calls for every put. Hopefully you are starting to imagine the versatility and power of options that simply are not available through stock investing alone.


Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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Listen to Jeff at www.ProfitStrategiesRadio.com  

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