Option Investor
Educational Article

A Simple Categorizing of Options and Option Strategies

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The Theory Behind the Practice

Everything in life that has significant revolves around some type of order. This order usually comes in the form of an organizational relationship between everything that is done under a unique subject. Organization of your house, organization of your bills, Organization of your clothes, Organization of the items in each of the individual rooms in your house or apartment. Your day-to-day activities would be in total chaos if you did not have them organized in some matter. The world of options is no different. All options and option strategies can be organized in a very simple process of categorizing. Lets take a look at how we can organize options and all their strategies. This organization for the new option trader is extremely essential, as it not only provides a good reference for traders to refer to, but a good reference for option traders (novice or old pros) to understand the relationship of options to all the strategies that can be utilized. In order to organize options in this manner, one need to understand the elements that make up the various option strategies that are currently used.

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Two Types of Options and their uses

There are only two types of options, Puts and calls. You can only do two things with those two types of options. Buy puts and calls or sell puts and calls. So your initial organization
chart looks like this.

FIGURE 1-1: PUTS AND CALLS CAN ONLY BE PURCHASED OR SOLD

So in the first step of the organization tree of an option you initially have:

1. A Call, which you can buy or sell
2. A Put, which you can buy or sell

Now, lets take the next step in the organizational tree. You can buy several types of puts or calls based on their relationship to the options strike price relating to the options underlying issues price. They are

1. Out-of-the money options
2. At-the-money options
3. In-the-money options

FIGURE 2-2 BUYING AND SELLING, PUTS AND CALLS, EITHER OUT, AT, OR IN-THE-MONEY OPTIONS


As you are slowly seeing in the organizational chart, that you can only do so many things with a PUT or CALL. That is to BUY or SELL them, in the money, out-of-the money or at-the-money option. So that gives us a total of12 alternatives that we have using the individual Put or Call as illustrated above.

Now understanding the above organization of Calls and Puts you will next come to see how this organization fits into the current world of option trading.
 

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