Strategic Financial Management · Options

Option Trading Strategies: Straddle, Strangle, Spreads and Butterfly

Q: What is the difference between a straddle and a strangle?

A straddle uses a call and a put at the same strike. A strangle uses an out-of-the-money put and an out-of-the-money call at different strikes. The strangle costs less, but the price must move further to reach profit.

Q: How do you calculate the payoff of a bull spread?

Find each call's payoff at the expiry price, with the sold call taken as negative. Add them, then subtract the net premium paid. Profit is capped at the strike difference less the net premium.

Q: When should you use a protective put or a covered call?

Use a protective put when you hold shares and want a floor on losses, accepting a premium cost. Use a covered call when you expect little rise in the price and want extra income from the premium, accepting capped gains.

Updated 11 October 2026 · Fact-checked

An option trading strategy combines calls, puts and sometimes the underlying share to get a chosen payoff shape. To solve a question, list every leg, compute each leg's profit at the given prices, add them up, then find break-evens, maximum profit and maximum loss.

Understand Option Trading Strategies

A single option gives a one-sided bet. A call gains when the price rises. A put gains when it falls. A strategy combines legs so the payoff fits your view: rising, falling, stable, or volatile.

There are three families. Hedging strategies protect a position. A protective put is long share plus long put. It sets a floor on loss. A covered call is long share plus short call. You earn the premium but give up gains above the strike.

Volatility strategies bet on the size of the move, not its direction. A long straddle is a long call and a long put at the same strike and expiry. A long strangle uses an out-of-the-money put and an out-of-the-money call. It costs less, but needs a bigger move to profit.

Spread strategies use options of the same type with different strikes. A bull call spread buys a low-strike call and sells a high-strike call. A bear put spread buys a high-strike put and sells a low-strike put. Both cap profit and loss. A long butterfly profits if the price stays near the middle strike. It is long one low-strike call, short two middle-strike calls, and long one high-strike call.

In every case the method is the same. Add the profit of each leg. Premium paid is a cost. Premium received is income.

Key rules to remember

Long call profit: max(S − X, 0) − premium; S is the price at expiry, X is the strike. Reverse the sign for a short call.
Long put profit: max(X − S, 0) − premium; Reverse the sign for a short put.
Protective put: Profit = (S − S0) + max(X − S, 0) − put premium; for X ≤ S0, maximum loss = (S0 − X) + put premium; S0 is the purchase price of the share. Break-even = S0 + premium. If X > S0, the position has a profit floor of (X − S0) − premium, so the loss is smaller than the premium and can even turn into a guaranteed profit if X − S0 exceeds the premium.
Covered call: Profit = (S − S0) − max(S − X, 0) + call premium; maximum profit = (X − S0) + premium; Break-even = S0 − premium. Loss is large if the price falls.
Long straddle: Break-evens = X ± (call premium + put premium); maximum loss = total premium; Profit is unlimited on the upside. On the downside it is limited only by the price falling to zero (maximum profit = X − total premium).
Long strangle: Break-evens = X_put − total premium and X_call + total premium; maximum loss = total premium; Put strike is below call strike. Loss is greatest when S lies between the two strikes.
Bull call spread: Maximum profit = (X2 − X1) − net premium; maximum loss = net premium; break-even = X1 + net premium; X1 is the lower strike (bought), X2 the higher strike (sold). Net premium = premium paid − premium received.
Bear put spread: Maximum profit = (X2 − X1) − net premium; maximum loss = net premium; break-even = X2 − net premium; X2 is the higher strike (bought), X1 the lower strike (sold).
Long call butterfly: Maximum profit = (X2 − X1) − net premium; maximum loss = net premium; break-evens = X1 + net premium and X3 − net premium; Strikes X1 < X2 < X3 equally spaced. Maximum profit occurs at S = X2.

How to solve Option Trading Strategies questions

Use the same leg-by-leg method for every strategy. It avoids formula mix-ups.

1Write down each leg: long or short, call or put, strike and premium.
2Compute the net premium: premiums paid are outflows, premiums received are inflows.
3Choose the key prices: each strike, and one price below and above all strikes.
4For each price, find each leg's payoff at expiry, then add them and subtract the net premium (or add the net credit).
5Find break-evens by locating where total profit is zero. Check each segment of the payoff.
6State the maximum profit and maximum loss. Mark any as unlimited.
7Link to the view: say when the strategy fits (rise, fall, stable, volatile) and give a recommendation if asked.

Quickest way: Strike-table shortcut

When to use it: Use for numerical questions that ask for payoff at several expiry prices or for the profit range.

Draw a small table with columns: price, each leg's payoff, total payoff, net profit.
Take prices at each strike and just beyond the outer strikes. The payoff is a straight line between these points.
Compute net profit at these points. Break-evens lie where the sign changes.
For a spread or butterfly, maximum profit and loss come directly from the table rows. The caps are visible at once.

Common mistakes in Option Trading Strategies

Ignoring the premium when finding break-even or profit.
You compute only the expiry payoff and stop.
Fix: Always finish with net profit = total payoff − net premium paid (or + net premium received).
Treating a short option's premium as a cost.
You apply the long-position sign to all legs.
Fix: The seller receives the premium. The buyer pays it. Mark each leg first.
Using one break-even for a straddle or strangle.
You are used to single-leg break-evens.
Fix: These strategies have two break-evens, one on each side of the strikes.
Mixing up bull call spread and bear put spread strikes.
You memorise the names but not which leg is bought.
Fix: In a bull call spread you buy the lower-strike call, which is the more expensive one, and sell the higher-strike call. In a bear put spread you buy the higher-strike put, which is the more expensive one, and sell the lower-strike put. Both are debit spreads.
Saying a covered call has unlimited profit.
You see the long share and forget the short call caps the gain.
Fix: Profit is capped at (X − S0) + premium. The loss on the downside is not capped, only cushioned by the premium.
Forgetting that the butterfly has four option contracts: one, two, one.
You treat the middle leg as a single contract.
Fix: Sell two middle-strike options. Include both in the premium and payoff calculation.

Worked examples

Example 1

A share trades at ₹200. You buy a call with strike ₹210 for a premium of ₹6 and buy a put with strike ₹190 for a premium of ₹4 (same expiry). Find the break-even prices, maximum loss, and profit if the price at expiry is ₹230.

Show the solution

This is a long strangle. Total premium = ₹6 + ₹4 = ₹10.
Upper break-even = 210 + 10 = ₹220.
Lower break-even = 190 − 10 = ₹180.
Maximum loss = ₹10 per share, when the price at expiry lies between ₹190 and ₹210.
At ₹230: call payoff = 230 − 210 = ₹20. Put payoff = 0.
Net profit = 20 − 10 = ₹10 per share.

Answer: Break-evens are ₹180 and ₹220. Maximum loss is ₹10 per share. At ₹230 the profit is ₹10 per share.

Example 2

You buy a call with strike ₹100 at a premium of ₹8 and sell a call with strike ₹110 at a premium of ₹3. Compute the payoff at expiry prices of ₹95, ₹105, ₹110 and ₹120, and find the break-even, maximum profit and maximum loss.

Show the solution

This is a bull call spread. Net premium paid = 8 − 3 = ₹5.
At ₹95: both calls expire worthless. Net profit = −₹5.
At ₹105: long call = 5, short call = 0. Total = 5. Net profit = 5 − 5 = ₹0.
At ₹110: long call = 10, short call = 0. Total = 10. Net profit = 10 − 5 = ₹5.
At ₹120: long call = 20, short call = −10. Total = 10. Net profit = 10 − 5 = ₹5.
Break-even = 100 + 5 = ₹105.
Maximum profit = (110 − 100) − 5 = ₹5. Maximum loss = ₹5.

Answer: Net profit is −₹5 at ₹95, ₹0 at ₹105, ₹5 at ₹110 and ₹5 at ₹120. Break-even is ₹105. Maximum profit is ₹5 and maximum loss is ₹5 per share.

Exam tips

Read the question for the market view. It tells you which strategy the examiner expects, such as a volatile view for a straddle.
Show the per-leg payoff table even when the question asks only for the break-even. Marks are given for working.
Check whether the question asks per share or for the whole lot. Multiply by the lot size only at the end.
In MCQs, test the answer at one price inside the range and one outside. It catches wrong break-even options quickly.
If premiums are given for a butterfly, verify the net premium with the 1, 2, 1 weights before computing anything else.

Practice questions from Options

Option Trading Strategies in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Option Trading Strategies: frequently asked questions

What is the difference between a straddle and a strangle?

A straddle uses a call and a put at the same strike. A strangle uses an out-of-the-money put and an out-of-the-money call at different strikes. The strangle costs less, but the price must move further to reach profit.

How do you calculate the payoff of a bull spread?

Find each call's payoff at the expiry price, with the sold call taken as negative. Add them, then subtract the net premium paid. Profit is capped at the strike difference less the net premium.

When should you use a protective put or a covered call?

Use a protective put when you hold shares and want a floor on losses, accepting a premium cost. Use a covered call when you expect little rise in the price and want extra income from the premium, accepting capped gains.

What is the payoff of a long butterfly spread?

It is long one low-strike call, short two middle-strike calls and long one high-strike call. Maximum profit occurs at the middle strike. Loss is limited to the net premium paid.