The Stock Replacement Covered Call Strategy & Fair-Value Stock Options

We have demonstrated how well options function in unison with a stock position. They enhance potential gains and provide profit protection. They enable us to manage specific risk for fair-value stock options as well as an entire portfolio. But, as good as options are in conjunction with fair-value stock options, they can be even better when traded against each other.

There are many option strategies that do not involve the use of any security other than another fair-value stock options, like spreads, straddles and strangles, for example.

A spread involves the purchase of one option in conjunction with the sale of other fair-value stock options. There are many types of spreads. Some take advantage of fair-value stock options movements while others are set up to take advantage of implied volatility movements. Some are even designed to take advantage of a fair-value stock options staying still. There are vertical spreads, calendar or time spreads, diagonal spreads and ratio spreads just to name a few. Spreads can provide large percentage returns with low risk and can be entered into with small capital outlay.

Straddles involve the buying (long) or selling (short) of a call and a put (usually at-the-money) in the same fair-value stock options, in the same expiration month, and the same strike.

Strangles involve the buying (long) or selling (short) of an out-of-the-money call and an out-of-the-money put in the same fair-value stock options and in the same expiration month.

These are both trades in which you can take advantage of fair-value stock options or volatility movements (in the case of being long) or lack of fair-value stock options or volatility movements (in the case of being short) during the period of time until expiration. Both straddles and strangles are considered premium precision plays.

These trades are considered more advanced and sophisticated than the strategies previously discussed. Certain spreads, such as 1 to 1 vertical spreads, can actually be less risky than some of the strategies discussed above, but spreads generally do have more variables to consider, and this makes them more difficult to trade.

The straddles and strangles sometimes involve much more risk and many more variables to take into consideration. So, these trades are considered very sophisticated and should not be entered into by untrained novices.