Free Option Position
The free option position is a directional trade in options tradingthat allows you to purchase an option with the premium you received from selling other options. It's a good position to use when you expect a directional move, and see strong technical support or resistance levels to trade against. This type of trade is used where there is higher implied volatility in out-of-the-money options than those near the market. The free option position usually involves buying a near-the-money option and selling an out-of-the-money call and put. For a bullish trade, the position would be a long near-the-money call and a short an out-of-the-money call and put. This results in a bull call spread combined with an unhedged short put. For a bearish trade, a near-the-money put is purchased and an out-of-the-money put and call is sold. If the market makes an anticipated directional move then the free option position can make good gains.
On the other hand, if the market moves significantly against the position, you should be quick to close or adjust the unhedged short option, which can give unlimited losses. Although this type trade has limited profit potential and unlimited loss potential, it can be appropriate when market conditions are right. As always, it's important to manage your money appropriately to minimize potential losses.
