Basic Strategies

With all the foundational concepts in place, you can now apply them to the four basic options strategies. The SIE tests breakeven calculations, max gain, and max loss for each position.

Long Call (Bullish)

• Action: Buy a call option
• Outlook: Expecting the stock price to rise
• Breakeven = strike price + premium paid
• Max loss = premium paid
• Max gain = unlimited (stock can rise indefinitely)

Example: Buy a 50 call for $3 premium.

• Breakeven = $50 + $3 = $53
• Max loss = $3 per share ($300 per contract)
• Max gain = unlimited

The stock must rise above $53 for you to profit. Below $50, the option expires worthless and you lose the $3 premium.

Exam Tip: Gotchas

• Buyers want the option to have value (exercise it). Sellers want the option to expire worthless (keep the premium). This distinction drives every options question on the exam.

Long Put (Bearish)

• Action: Buy a put option
• Outlook: Expecting the stock price to fall
• Breakeven = strike price - premium paid
• Max loss = premium paid
• Max gain = strike price - premium (stock falls to $0)

Example: Buy a 50 put for $2 premium.

• Breakeven = $50 - $2 = $48
• Max loss = $2 per share ($200 per contract)
• Max gain = $50 - $2 = $48 per share ($4,800 per contract)

The stock must fall below $48 for you to profit. Above $50, the option expires worthless and you lose the $2 premium.

Short Call (Bearish/Neutral)

• Action: Sell (write) a call option
• Outlook: Expecting the stock price to stay flat or decline
• Breakeven = strike price + premium received
• Max gain = premium received
• Max loss = unlimited (if uncovered)

Example: Sell a 50 call for $3 premium.

• Breakeven = $50 + $3 = $53
• Max gain = $3 per share ($300 per contract)
• Max loss = unlimited (if the stock rises far above $53)

You profit if the stock stays below $53. Your best-case scenario is the option expiring worthless, and you keep the full premium.

Loss example: Sell an uncovered 55 equity call for a $4 premium per share. At expiration, the stock is $65 and the call is assigned. Ignoring transaction costs:

• Buy shares at $65 and deliver them at the $55 strike: loss before the premium = $65 - $55 = $10 per share.
• The call's $10 intrinsic value is this price difference, not a separate assignment fee.
• Subtract the premium received: net loss = $10 - $4 = $6 per share.

Exam Tip: Gotchas

• Long positions have limited loss (premium paid). Short positions can have very large or unlimited losses. A short call has unlimited risk because the stock can rise indefinitely.

Short Put (Bullish/Neutral)

• Action: Sell (write) a put option
• Outlook: Expecting the stock price to stay flat or rise
• Breakeven = strike price - premium received
• Max gain = premium received
• Max loss = strike price - premium (stock falls to $0)

Example: Sell a 50 put for $2 premium.

• Breakeven = $50 - $2 = $48
• Max gain = $2 per share ($200 per contract)
• Max loss = $50 - $2 = $48 per share ($4,800 per contract)

You profit if the stock stays above $48. If the stock drops to $0, you must buy it at $50 but only received $2 in premium.

Combining Stock with Options

The four positions above are naked (stock is not involved). The SIE also tests two strategies that pair a long stock position with an option: the covered call and the protective put. Both were introduced conceptually in Hedging vs. Speculation; here are their breakeven formulas.

Covered Call (Long Stock + Short Call)

• Action: Own the stock, sell a call against it
• Outlook: Neutral to mildly bullish; willing to cap upside for income
• Breakeven = stock purchase price - premium received

Example: Buy stock at $40, sell a 45 call for $3 premium.

• Breakeven = $40 - $3 = $37
• Stock gain up to the strike = $45 - $40 = $5
• Max gain = stock gain up to the strike + premium = $5 + $3 = $8 per share
• Max loss = purchase price - premium = $40 - $3 = $37 per share (if the stock falls to $0)

The premium received lowers the price at which you break even, cushioning a stock decline.

Protective Put (Long Stock + Long Put)

• Action: Own the stock, buy a put on it
• Outlook: Bullish, but paying for insurance against a drop
• Breakeven = stock purchase price + premium paid

Example: Buy stock at $40, buy a 35 put for $2 premium.

• Breakeven = $40 + $2 = $42
• Max gain = unlimited (stock can rise indefinitely, minus the premium paid)
• Unprotected drop to the strike = $40 - $35 = $5
• Max loss = unprotected drop + premium = $5 + $2 = $7 per share

The premium paid raises the breakeven, since it is an added cost on top of the stock.

Exam Tip: Gotchas

• A covered call's premium is received, so it is SUBTRACTED from the stock price to find breakeven. A protective put's premium is paid, so it is ADDED to the stock price. This is the opposite of the naked call/put rule above, because here the premium is adjusting a stock cost basis, not an option strike.
• Covered call caps the upside; protective put caps the downside. Neither eliminates all risk: a covered call still loses money if the stock falls, and a protective put still costs the premium even if the stock never drops.

Breakeven Formula Summary

Notice the pattern for an option held alone:

• Calls: Strike + premium (regardless of long or short)
• Puts: Strike - premium (regardless of long or short)
• With stock: start from the stock purchase price, not the strike. A protective put adds the premium paid; a covered call subtracts the premium received.

Exam Tip: Gotchas

• For an option held alone, calls add and puts subtract. Given only a strike price and premium, add the premium to a call's strike and subtract it from a put's strike. This works for both long and short positions.
• The shortcut fails once the investor also owns the stock. Breakeven then starts from the stock purchase price. Buy stock at $60 and a 60 put for $4: breakeven is $60 + $4 = $64, not $60 - $4 = $56, because the premium paid is an added cost on the shares. A covered call subtracts the premium received from the stock price.
• The breakeven formula is the same whether you are long or short. What changes is which side of breakeven counts as profit vs. loss.

Max Gain and Max Loss Summary

Quick Reference: Who Wants What?

What Should You Check on Exam Day?

• Can you calculate breakeven for a long call, long put, short call, and short put?
• Do you know why a short call has unlimited max loss while a long call's max loss is only the premium?
• Can you explain why, for an option held alone, calls add the premium to the strike and puts subtract it for breakeven?
• Do you know why a covered call subtracts the premium from the stock price, while a protective put adds it, even when the put's strike equals the stock price?
• Can you explain the difference between what a covered call caps, the upside, and what a protective put caps, the downside?