Covered calls, spreads, and straddles

With calls, puts, and the Greeks in place, you can combine options into strategies that express a precise view: "I expect a modest rise", "I expect a big move but don't know which way", or "I'm happy to sell my shares at a higher price". This lesson covers three of the most widely used building blocks. Each one is shown with its maximum gain, maximum loss, and breakeven — the three numbers you must know before placing any options trade.

What you'll learn

• Covered calls: generating income from shares you own
• Vertical spreads: defined-risk directional trades
• Long straddles: trading an expected move in either direction
• Why short straddles and other uncovered strategies are not for beginners
• How to choose a strategy to match your view

1. Covered call

Structure: own 100 shares + sell one call (usually out of the money).

View: neutral to modestly bullish — you're happy to sell the shares at the strike.

Worked example

(Illustrative.) You own 100 shares bought at $100. You sell a 30-day $110 call for $2.00 ($200).

• Maximum gain: (strike − purchase price + premium) × 100 = $1,200
• Breakeven: purchase price − premium = $98
• Maximum loss: substantial — you still own the shares, cushioned only by the premium

2. Vertical spreads

A vertical spread buys one option and sells another of the same type and expiry at a different strike. The sold option reduces cost — and caps profit.

Bull call spread (debit spread)

Structure: buy a lower-strike call + sell a higher-strike call. View: moderately bullish.

(Illustrative.) Stock at $100. Buy the $100 call for $5.00, sell the $110 call for $1.80.

• Net cost (debit): $5.00 − $1.80 = $3.20 ($320 per spread) — the maximum loss
• Maximum gain: (110 − 100 − 3.20) × 100 = $680, reached at $110 or above
• Breakeven: 100 + 3.20 = $103.20

Compare with buying the $100 call alone: cheaper, lower breakeven ($103.20 vs $105), and much less sensitive to time decay and IV crush — in exchange for capped upside.

Other verticals

Every vertical spread has defined maximum risk — a big reason they're the recommended way to learn directional options trading.

3. Long straddle

Structure: buy a call and a put at the same strike (usually at the money) and expiry. View: a large move is coming, direction unknown.

(Illustrative.) Stock at $100. Buy the $100 call for $5.00 and the $100 put for $4.50.

• Total cost: $9.50 ($950) — the maximum loss, if the stock sits at $100 at expiry
• Breakevens: 100 + 9.50 = $109.50 and 100 − 9.50 = $90.50
• Profit if the stock moves beyond either breakeven

The catch: straddles are most tempting before big events — exactly when IV is highest and options most expensive. After the event, IV crush can erase much of the value unless the move is larger than what was priced in (see The Greeks).

Short straddles: not for beginners

Selling a straddle collects both premiums and profits if the price stays still — but has unlimited risk on the upside and very large risk on the downside. It is one of the classic ways experienced traders suffer catastrophic losses. Avoid uncovered short options until you have extensive experience and a defined-risk plan.

4. Matching strategy to view

Common beginner mistakes

• Treating covered calls as protection.
• Buying straddles when IV is already very high before events.
• Selling uncovered options for "consistent income".
• Ignoring early assignment risk on short options near ex-dividend dates or expiry (American-style).
• Not sizing by maximum loss.

Key terms

Practice

1. For a liquid stock, price a bull call spread and the equivalent long call. Compare cost, breakeven, and maximum gain.
2. Price an ATM straddle before an earnings report. Compare its breakevens with the implied move.
3. For each strategy you might use, size a position so its maximum loss equals 1% of your account.
4. Paper-trade one defined-risk spread through to expiry and record how theta and IV affected it.

Quick recap

• Covered calls earn premium on shares you own, but cap upside and don't protect downside.
• Vertical spreads offer directional exposure with defined risk — ideal for learning.
• Long straddles profit from large moves in either direction, but suffer from high IV and time decay.
• Short straddles and uncovered options carry large or unlimited risk — avoid as a beginner.
• Always know maximum gain, maximum loss, and breakeven, and size by maximum loss.

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