What Are the Building Blocks?

Every position in a stock and its options is built from six pieces. Each has a payoff diagram: a picture of what the position is worth at expiration, against the share price.

Long stock: a straight line, rising one for one with the share price.

Short stock: the same line, falling.

Long call: zero below the strike, then rising one for one above it. Traders call the shape a hockey stick.

Short call: zero below the strike, then falling one for one above it.

Long put: rising one for one as the price falls below the strike, zero above it.

Short put: losing one for one as the price falls below the strike, zero above it.

Strategies are sums. Add the payoffs of the pieces at each share price, and you have the payoff of the whole position.
Engraving of an open wooden box holding six carved wooden blocks, each with a differently shaped top, on a scholar’s desk

Remember

Four things to keep in mind when you build with the blocks.

  • Payoffs add. A strategy’s payoff at any share price is the sum of its pieces’ payoffs at that price.

  • Selling a piece instead of buying it flips its diagram upside down.

  • Calls bend at the strike and rise to the right; puts bend at the strike and rise to the left.

  • Put–call parity links the blocks: a long call and a short put at the same strike together behave like long stock.

Snapping Strategies Together

The top of the chart shows the six blocks, each with a $100 strike. They are payoffs at expiration, with the option premiums left out, so each picture shows only what the position is worth when the options expire.

Below, three common strategies are assembled from them:

Covered call = long stock + short call. The short call gives up the stock's gains above the strike, in exchange for the premium it brings in.

Protective put = long stock + long put. The put sets a floor under the stock. The combined shape is the same as a long call's.

Bull call spread = long $100 call + short $110 call. The short call caps the gain at $10 and lowers the cost of the trade.

The protective put matching a long call is no coincidence. It is put–call parity, which ties the blocks together:

\(S + P = C + K e^{-rT}\)

Stock plus a put is worth the same as a call plus cash equal to the strike's present value.
Chart: payoff diagrams of the six building blocks, and a covered call, protective put and bull call spread built from them

More Strategies from the Same Six Pieces

  • Straddle

    Buy a call and a put at the same strike. Two blocks give a V-shaped payoff that pays off when the stock moves far in either direction, up or down.

  • Iron Condor

    Sell an out-of-the-money put and call, then buy a put and a call further out as protection. Four blocks give a flat top in the middle and losses capped on both sides.

  • Synthetic Stock

    Buy a call and sell a put at the same strike. The pair moves one for one with the stock, like owning the shares, for little money up front.

FAQ

  • What are the six building blocks of option strategies?

    Long stock, short stock, long call, short call, long put and short put. Every strategy built from a stock and its options is some combination of these six, in different amounts and at different strikes.

  • What is a payoff diagram?

    A graph of what a position is worth at expiration, plotted against the share price at expiration. It shows at a glance where a strategy makes money, where it loses, and where the gains or losses stop.

  • What is the difference between payoff and profit?

    Payoff is what the position is worth at expiration. Profit subtracts what you paid for it, or adds what you received. A call with a $100 strike pays $10 if the stock ends at $110; if the call cost $4, the profit is $6.

  • How is a covered call built from the blocks?

    It is long stock plus a short call. The stock’s line rises one for one, and the short call bends it flat above the strike. The result keeps the stock’s losses below the strike, caps its gains above it, and collects the call’s premium.

  • What is a synthetic position?

    A combination of blocks that behaves like a different block, by put–call parity. A long call plus a short put at the same strike acts like long stock; long stock plus a long put acts like a long call. Traders use them when the synthetic version is cheaper or easier to trade.

Learn the Building Blocks and the Strategies Made from Them

Our Stock Options course covers the six building blocks, payoff diagrams and the strategies built from them, along with the Greeks and implied volatility, in video lessons with quizzes.