All About Neutral Options Strategies
Neutral options strategies, which are also often referred to as non-directional strategies, have been named so because potential profits emerging from them don’t have anything to do with the rise and fall of stock prices. They come into play when options traders don’t have any clue about how well a particular underlying stock would perform. In other words, these trading strategies are used when options traders don’t know whether prices of underlying stocks would fall or rise. So, what do they depend on? Ideal neutral strategies depend on the anticipated volatility of underlying stock prices.
Neutral Options Strategies For High Implied Volatility
Short straddles and strangles- These neutral strategies are used in options trading involving concurrent selling of slightly out-of-money puts and out-of-money calls having the same expiration date and underlying stock.
Iron condors- If you don’t like the fact that short strangle comes with unlimited risk, opt for iron condors. Unlike the short strangles, iron condors are limited risk, non-directional options trading strategies that have been designed for offering a significant probability of enjoying a limited profit when it is perceived that the underlying security has low volatility.
Naked puts & calls- Many refer to this as uncovered options; however, “naked” is the more commonly used term, possibly due to the additional fun the term brings in to the concept. It is actually exactly the opposite of covered calls.
Uncovered or naked calls occur when the seller or the writer of a particular option doesn’t possess any underlying stock for fulfilling his part of the options trade. This means, when a call buyer gets hold of an option of a certain value, the seller would need to endure with the linked stock. If the seller is naked, he will not possess the said stock when selling his call option.
You can call a put naked when the option’s writer doesn’t have any financial resource available for buying underlying shares for the put’s strike price.
Neutral Options Strategies for Low Implied Volatility
Put or call debit spreads- Put debit spreads are options spread strategies created when identical number of put options are purchased and sold at the same time. Unlike put buying strategies, in which profit potential becomes really unlimited, put spreads are capable of offering limited profit. However, it is important to remember that put spreads are also relatively inexpensive to employ.
Call debit spreads, on the other hand, are vertical spreads featuring a couple of calls boasting identical expiration, but diverse strikes. Strike prices of short calls are more than strike prices of long calls. As a result, the strategy always needs an initial debit/outlay.
Radio spreads- You can think of using ratio spreads when you have extremely strong directional assumptions. This neutral strategy of options trading involves purchasing a series of different options and selling off more options having identical expiration date and underlying stock for different strike prices. This neutral options strategy offers limited profit and exposes the trader to unlimited risk. The strategy is adopted mostly when the trader feels that an underlying stock he owns will experience minimum volatility during the upcoming term.
Put or call calendar spreads- Calendar spreads are directionally neutral, low risk strategies that make profit from time or rise in IV (implied volatility). Calendars are comprised of one long option and one short option (puts or calls) with long-term expiration cycle and short-term expiration cycle respectively. Both these options belong to the same category and use similar strike prices.
What is the maximum profit potential of a calendar spread? Maximum profit potential of these spreads cannot be calculated. That’s because the two options in it have diverse expiration cycles. However, it can be said that one of the most prominent outcomes for these spreads occur when the price of the trade becomes double of the original price.
How would you know the break-even of calendar spreads? As the options of these spreads have different expiration cycles calculating the break even for calendar spreads is also impossible. However, a finance expert can provide you with some guidelines that can help you have some idea about the break-even.
Summary: Neutral options strategies are applied by traders when they don’t know how an underlying stock would perform. The strategies are adopted depending on whether the implied volatility is high or low.