Risk and reward of a synthetic option position
You sold a call, and have a risk if the stock rises.  You bought a put and gain when the stock drops. You, sir, have a synthetic short position.  It's Case 3 from your linked example: Suppose you own Long Stock and the company is going to report earnings   but you’re going on vacation. How can you hedge your position without   selling your stock? You can short the stock synthetically with   options! Short Stock = Short Call + Long Put They conclude with the net zero remark, because the premise was an existing long position. A long plus this synthetic short results in a neutral set of positions (and the author's ability to go on vacation not concerned about any movement in the stock.) But if underlying goes to 103 at expiration, both the call and the put   expire worthless If the stock closes at 103 on expiration, the 105 put is worth $2, not worthless.
The risk-reward relation depends on what you are changing. In the most cases people ask about, it is not linear but I will give examples of both. Nonlinear case 1:  As you diversify your portfolio, the firm-specific risks of various stocks cancel each other out without necessarily affecting the expected return of the portfolio.  Reduction in risk without any loss in returns--very nonlinear.  Nonlinear case 2: If you are changing the weights in your portfolio to move along the efficient frontier, then you the risk-reward relation is a hyperbola, which is nonlinear. Nonlinear case 3: If you are changing the weights in your portfolio to move away from the efficient frontier, then you increase risk without adding a fully compensatory amount of return.  There could be many paths along the risk-reward plane, but generally it will not be linear in the sense that it will not be on the same line as your initial, efficient, portfolio and your savings account. Linear case 1: The most common sense in which we think of the risk-reward relation being linear is when the thing you are changing is the size of your investment.  If you take money out of savings to put in your fully diversified portfolio without changing the relative weights, your expected returns will increase linearly. Linear case 2: If you believe the CAPM, then the expected return of an asset stock is linearly proportional to the market risk of the firm.  If you could change the market risk of a single asset without changing anything else, then you would linearly change its expected return. The general rule about the risk/reward relation is this: If you are changing the size of your investment, the relation is linear.  If you are changing its composition, the relation is nonlinear "Depends on how far down the market is heading, how certain you are that it is going that way, when you think it will fall, and how risk-averse you are.  By ""better"" I will assume you are trying to make the most money with this information that you can given your available capital. If you are very certain, the way that makes the most money for the least investment from the options you provided is a put.  If you can borrow some money to buy even more puts, you will make even more.  Use your knowledge of how far and when the market will fall to determine which put is optimal at today's prices.  But remember that if the market stays flat or goes up you lose everything you put in and may owe extra to your creditor.  A short position in a futures contract is also an easy way to get extreme leverage.  The extremity of the leverage will depend on how much margin is required.  Futures trade in large denominations, so think about how much you are able to put to risk. The inverse ETFs are less risky and offer less reward than the derivative contracts above.  The levered one has twice the risk and something like twice the reward.  You can buy those without a margin account in a regular cash brokerage, so they are easier in that respect and the transactions cost will likely be lower. Directly short selling an ETF or stock is another option that is reasonably accessible and only moderately risky.  On par with the inverse ETFs." Stock portfolios have diversifiable risk and undiversifiable risk.  The market rewards investors for taking undiversifiable risk (e.g. owning an index of oil producing companies) and does not reward investors for assuming diversifiable risk (e.g. owning a single oil producing company).  The market will not provide investors with any extra return for owning a single oil company when they can buy an oil index fund at no additional cost. Similarly, the market will not reward you for owning a small-cap index fund when you can purchase a globally diversified / capitalization diversified index fund at no additional cost.  This article provides a more detailed description. The Vanguard Total World Stock Index Fund is a much better staring point for an equity portfolio. You will need to make sure that the asset allocation of your overall portfolio (e.g. stocks, bonds, P2P lending, cash) is consistent with your time horizon (5-10 years). "How do option market makers actually hedge their positions so that they do not have a price risk? You cannot complete hedge away price risk of a sold call simply by buying the underlying and waiting.  As the price of the underlying decreases, the ""Delta"" (price risk) decreases, so as the underlying decreases, you would gradually sell some of the underlying to reduce your price risk from the underlying to match the price risk of the option. The opposite is true as well - as the price of the underlying increases, you'd buy more of the underlying to maintain a ""delta neutral"" position. If you want to employ this strategy, first you need to fully understand what ""delta"" is and how to calculate it.  Then you can use delta hedging to reduce your price risk." 1. It doesn't have an almost perfect negative correlation - its value decays very fast because of time.  In fact, something like 80% of options expire worthless.  They typically have a lifespan of 30-90 days and unless you're using them as a way to earn excess return, you'll likely just throw away your premium.  2. You're also making some assumptions about correlation and risk/reward.  You won't become wealthy by distributing risk, all you can hope for is less volatility - maybe that's what you're looking for - but you can also expect your return to be less than the market over almost any period of time.  3. Options aren't really for diversifying.  Furthermore, why diversify?  It's a myth that it adds any value.  There's around a 90% correlation for all asset classes since around 2000, so you're being sold some blue sky if someone tells you otherwise.  4. Look up prices of put options.  1-2% of your portfolio might buy you a handful of options, but again, there's a high probability you'll lose that 1-2% entirely every 30-90 days. I don't have a direct short position. It is a structured product linked to the performance of Tesla. I basically get a fixed coupon payment every quater and as long as Tesla doesn't move up more than 50% in the next half year I get my initial investment back plus the coupons. If it should move up more than 50% I lose that percentage of my initial investment "SELL -10 VERTICAL $IYR 100 AUG 09 32/34 CALL @.80 LMT 1) we are talking about options, these are a derivative product whose price is based on 6 variables. 2) options allow you to create risk out of thin air, and those risks come with shapes, and the only limit is your imagination (and how much your margin/borrowing costs are). Whereas a simple asset like the shares for $IYR only has a linear risk profile. stock goes up, you make money, stock goes down, you lose money, and that risk graph looks linear. a ""vertical"" has a nonlinear risk profile 3) a vertical is a type of ""spread"" that requires holding options that expire at the same time, but at different strike prices. 3b) This particular KIND of vertical is called a bear call spread (BCS). Since you are bearish (this makes money if the stock goes down, or stays in a very specific range) but are using calls which are a bullish options product. 4) -10 means you are selling the vertical. +10 means you are buying the vertical. A ""long"" vertical is initiated by buying an option closer to the money, and selling an option at a higher strike price. This would be +X A ""short"" vertical is initiated by selling an option closer to the money and buying an option at a higher strike price. The quantity would be -X 5) 32/34 stands for the strike prices. so you would be selling 10 call options at the 32 strike price, and buying 10 call options at the 34 strike price, both options expire in August 6) LMT stands for limit order, and $.80 is the limit order price that is desired. OPENING a vertical spread requires knowledge of options as well as how to send orders. MANAGING a vertical requires even more finesse, as you can ""leg-in"" and ""leg-out"" of spreads, without sending the entire order to the exchange floor at once. There is much to learn." What Jaydles said. I think of each strategy in terms of Capital at Risk (CaR). It's a good thing to know when considering any position. And then conveniently, the return is always profit / CaR. With covered calls it's pretty easy. Pay $1000 for stock, receive $80 in premium, net CaR is $920.  If you own the stock and write calls many times (that expire worthless, or you that you buy back), there are two measurements to consider. First, treat every covered call as a buy-write. Even if you already own the stock, disregard the real cost basis, and calculate from the moment you write the call, using the stock price at that time. The second measure is more complicated, but involves using something like the XIRR function in a spreadsheet. This tracks the series as a whole, even accounting for times where there is no written call outstanding. For the written put, even though your broker may only require 30% collateral in a margin account, mentally treat them as cash-secured. Strike less premium is your true CaR. If the stock goes to zero by expiration, that's what you're on the hook for. You could just compute based on the 30% collateral required, but in my view that confuses cash/collateral needs with true risk. Note: a written put is exactly identical to a covered call at the same strike. If you tend to favor puts over CCs, ask yourself why. Just like a loaded gun, leverage isn't inherently bad, but you sure want to know when you're using it.