Talking about the mechanics of an option strategy can be difficult enough. How about a discussion that relates to how one actually implements a position in the real world.

For example, say you want to implement a covered call write on XYZ. Further let’s assume that XYZ is trading at $50 per share and the July 55 call is trading at $5 per share. Ideally you want to buy the stock at $50 and write the July 55 call at $5. The problem is trying to execute two separate trades one leg at a time.

The solution is not to try. What you want to do is enter a buy write order with a net debit. Let the traders at the brokerage firm decide how to implement the order. In the XYZ example, you would request a buy write where you are willing to buy the stock and write the call at a net debit of $45 per share. It doesn’t matter if you pay $50.25 to buy XYZ, as long as you receive $5.25 from the sale of the July 55 call.

Most brokerage firms will do these kinds of trades, and some will even enter spread orders as a spread. Sometimes charging a little less on the overall spread than would be the case if you legged into it one side at a time.

But it’s important to note, that any trade involving two sides should be implemented as a net position. Which obviously holds for spreads, which can be net debit or credit positions. Say you want to implement a bull call spread on XYZ. The XYZ July 45 call is trading at $9.50 per share, and the XYZ July 55 call is trading at $5. You could buy the XYZ July 45 call and write the XYZ July 55 call for a net debit of $4.50. Enter the order then as a spread with a net debit.

Credit spreads are the same. If you were bearish on XYZ you could write the XYZ July 45 call and buy the XYZ July 55 call for a net credit of $4.50 per share. Again, enter the order for as a bear call spread with a net credit.

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One question that continues to come up centers around exotic option trades. Many of these complex models are not of much use to the average investor. Although some do show promise under the right circumstances. One of the more interesting exotic option trades, is the so-called butterfly spread.

Essentially the butterfly spread is a combination of a bull call spread and a bear call spread. The butterfly spread is designed to make money if the stock remains in a relatively narrow trading range. What makes this trade interesting is that it has limited risk. Even if the stock breaches the outside boundaries of the trading range. Moreover, the butterfly spread has a high reward to risk ratio, especially given its limited risk.

Having framed the positive side of this trade, individual investors would have a difficult time implementing it. One of the reasons the strategy has also been referred to as an alligator spread. It eats you alive in commissions.

The strategy works this way. Suppose XYZ is trading at $50 per share. If you believe it will remain in a trading range between $40 and $60 between now and say, the May expiration, you could use a butterfly spread. We’ll assume that the following prices exist; the May 40 calls are trading at $13, the May 50 calls are trading at $7.50 and the May 60 calls are trading at $3.50.

The butterfly spread consists of buying one XYZ May 40 call (price $13), writing two XYZ May 50 calls ($7.50 x 2 = $15 net credit) and buying one XYZ May 60 call ($3.50). The purchase of the May 40 and May 60 calls will cost you a total of $16.50 per share. The sale of the two May 50 calls will provide a credit of $15 per share. You total risk then, is the net out-of-pocket cost ($1.50) for putting the spread together.

You would make money on this trade if the stock closes between $41.50 and $58.50 per share at the May expiration. For example, if the stock closes at $45 per share, the XYZ May 50 call and the XYZ May 60 calls would expire worthless. However, you would be able to sell your XYZ May 40 calls at $5 per share. Net profit, $3.50 per share ($5 less $1.50 cost).

Ideally, you want the stock to close at exactly $50 per share at expiration. At that point the May 50 and May 60 calls would expire worthless, but your May 40 call would be worth $10 per share. In other words, at $50 per share, you earn $10 profit on a $1.50 initial investment. That is a return of 666% on the initial investment. Or put another way, the potential return is six times the potential risk.

In terms of your risk, it is also limited. Suppose XYZ rises to $100 per share. You would sell your May 40 call at $60, and your May 60 call at $40. That’s $100 from the sale of the two long call positions. However, you would also be required to settle your two short May 50 calls, which would cost you $50 each ($100 total) to close out. Bottom line the positions wipe each other out, except for the initial $1.50 investment. Total loss if the stock were to rise dramatically is $1.50.

Same situation if the stock closes below $40 per share. At any price below $40, all of the options expire worthless. Again, your maximum loss is $1.50 per share.

The downside to this trade is transaction costs. Professional floor traders can use this trade to their benefit because they pay very low transaction costs. But for the average trader, you have to implement three trades to enter the position and potentially three trades to exit the position. Add six transaction costs into the equation and your potential profit zone can shrink substantially.