Overview
These are a set of ‘neutral’ strategies that traders will use to hedge their risks. Both involve buying or selling simultaneously in-the-money call and put options that have the same expiration date or period and use the same underlying stock.
Long Guts Spreads
This is usually used by traders when they suspect that a stock will have high volatility in the short term. The trader will buy both call and put options.
The long guts spread has
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Unlimited profit potential: If the underlying stock of both options makes a strong move either upwards or downwards then there is the possibility of high profit. This movement must be very strong so that even as one of the options becomes worthless, the profit on the other option is strong enough to offset this loss.
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Limited risk potential: The only loss that is risked in this strategy is the loss of time value of the money. If both options trade within the strike prices, then that is the maximum loss possible in this situation.
Short Guts Spread
If a trader suspects that a stock will experience little volatility in the near future, then they might use this strategy. They will sell both a call option and a put option.
This is not a very good strategy. The short guts spread has
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Limited profit potential: The maximum profit possible in this scenario is when both options are trading between the strike prices at the end. The trader takes advantage of the loss in time value to make a profit. This is not a very high profit.
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Unlimited risk: There is the potential for very high losses for the trader if the underlying stock makes a sharp move upwards or downwards.