Basic Options Strategies

Core idea

Four positions are the building blocks of everything

Every strategy in this book is built from one or more of these four single-leg trades:

• Long call — pay premium, profit if the stock rises above strike + premium.
• Short call — receive premium, profit if the stock stays below strike + premium.
• Long put — pay premium, profit if the stock falls below strike − premium.
• Short put — receive premium, profit if the stock stays above strike − premium.

Each one has a directional bias, a defined or undefined risk profile, and a strike that can be slid up or down to calibrate the risk-reward.

The four payoff shapes

Long call: capped loss (premium), uncapped gain. Short call: capped gain (premium), uncapped loss. Long put: capped loss (premium), large but capped gain (stock to zero). Short put: capped gain (premium), large but capped loss (stock to zero).

The asymmetry is the point. Bought options can only lose what you paid. Sold options can lose far more than the premium received. This is the central fact that should govern position sizing for every strategy in the book.

Strike selection is the risk dial

Within any of the four positions, moving the strike is how you turn the risk dial. Buying an in-the-money call costs more but is more likely to keep some value. Buying a deep out-of-the-money call costs little but is more likely to expire worthless. The strike chosen — not the strategy chosen — is often where the actual trade decision happens.

Why it matters

Single-leg trades are the foundation

A trader who hasn't internalized the payoff shapes of the four primitives will struggle with every multi-leg strategy that follows. A bull call spread, for instance, is just a long call combined with a short call at a higher strike. You can't reason about the spread if the components are unfamiliar.

"Shift-on-the-fly" trading builds spreads from primitives

Royal's framing: you don't always set up a complex strategy from scratch. You may buy a long call today, watch the stock rise, and then sell a higher-strike call against it tomorrow. Without realizing it, you've constructed a bull call spread by combining two single-leg trades at different times. Fluency in the primitives lets you adapt mid-trade.

Selling naked options without huge capital is reckless

Uncovered short calls have unlimited loss potential — if the stock triples overnight, you owe the difference. Even uncovered short puts can wipe out an account if a stock gaps to zero. Brokers require Level 3 or 4 approval for naked selling, and beginners should treat it as off-limits until covered and spread variants are second nature.

Key takeaways

Mental model

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Practical application

Calibrating with strike selection

For each strategy, three strike choices set the risk dial:

• In-the-money (ITM) — higher premium, higher delta, more likely to retain value, less leverage.
• At-the-money (ATM) — moderate premium and delta, balanced risk-reward, highest gamma.
• Out-of-the-money (OTM) — low premium, low delta, lottery-ticket payoff, high probability of total loss.

For a long call on a stock at $40: buying the $37.50 strike (ITM) for $4.50 is the conservative choice. Buying the $42.50 strike (ATM/OTM) for $2.50 is the balanced choice. Buying the $47.50 strike (deep OTM) for $0.75 is the lottery-ticket choice. All three are "long calls" on the same stock — but the trades behave very differently.

Sequence: paper-trade each of the four

Before risking real money, paper-trade at least five examples of each primitive. Track how each one reacts to: (1) the stock moving up, (2) the stock moving down, (3) the stock staying flat, (4) a week passing with no movement, (5) an IV spike before earnings.

Sizing on long options

Treat the entire premium as at-risk. Position size = (account risk budget per trade) ÷ (premium per contract). If you have $500 to risk on a trade and the premium is $2.50, that's 2 contracts (2 × 100 × $2.50 = $500). Don't size off "what could it be worth?" — size off "what if it goes to zero?"

Example

Three strike choices for the same long call

Stock ABC trades at $40. You believe it will rise to $45–$50 over six months. Three long-call setups:

Lower-risk: $37.50 strike, premium $4.50.

• Breakeven: $42 (strike + premium)
• Max loss if ABC ≤ $37.50: −$4.50 per share (−100%)
• At $45 expiration: $45 − $37.50 − $4.50 = +$3.00 per share (+67%)
• At $50 expiration: $50 − $37.50 − $4.50 = +$8.00 per share (+178%)

Base: $42.50 strike, premium $2.50.

• Breakeven: $45 (strike + premium)
• Max loss if ABC ≤ $42.50: −$2.50 (−100%)
• At $45 expiration: $45 − $42.50 − $2.50 = $0 (breakeven)
• At $50 expiration: $50 − $42.50 − $2.50 = +$5.00 (+200%)

Higher-risk: $47.50 strike, premium $0.75.

• Breakeven: $48.25
• Max loss if ABC ≤ $47.50: −$0.75 (−100%)
• At $45 expiration: $0 above strike → −$0.75 (−100%)
• At $50 expiration: $50 − $47.50 − $0.75 = +$1.75 (+233%)

Same thesis, three radically different outcomes. The $37.50 call keeps some value even if ABC barely moves to $42. The $47.50 call only pays off if ABC explodes past $48. The strike is the trade decision.

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