Even though options trading has a lot of moving parts, most investors may utilize simple tactics to increase returns, wager on market movements, or protect current positions. When you already own shares in the underlying company, you can employ covered calls, collars, and married puts to protect your investment. Spreads are made when one or more options are bought and another or more options are sold at the same time. You can make money with long straddles and strangles whether the market goes up or down.
Using options trading, you can purchase or sell stocks, ETFs, etc., at a designated price within a designated period. Furthermore, this kind of trading allows consumers the choice not to purchase the asset at a designated price or date. Long call options, short call options, long put options, short put options, long straddle options, and short straddle options are among the option trading strategies. In-the-money, at-the-money, and out-of-the-money are the three primary choice trading situations.
Options trading offers leverage, cost-effectiveness, flexibility, options strategies, and hedging, among other things. Call and put options are two varieties of options seen in the stock market. A "call option" is a purchase option for a stock; a "put option" is a selling option for a stock.
Before learning about option trading strategies, you need to understand what option trading is? Trading isn't inherently difficult, but if you start trading without knowing these strategies, your chances of incurring losses will increase significantly.
What is Options Trading?
Options trading entails the purchase and sale of options contracts. These contracts are connected to an underlying asset and grant the owner the option to buy or sell a specific amount of that asset at a predetermined price within a specified time. "Essentially, the purchase of an option does not involve directly buying or selling the stock. Instead, it grants you a contract that grants you the ability to buy or sell the stock at a predetermined price.
The buyer of an option has the right, but not the responsibility, to buy (call option) or sell (put option). This right is granted to the buyer through the trading of options. Trading options entail employing tactics that give traders access to a variety of market positions, allowing them to either make profits or reduce the risk associated with the spot market.
What is an Option Chain?
An option chain, also known as an option matrix, is a crucial tool in the realm of options trading. It offers traders and investors a thorough perspective on the various options available for a specific underlying asset, such as stocks, indices, or commodities. Imagine it as a selection of options, each offering a distinct agreement that provides certain rights and responsibilities.
One way to describe all the available options contracts for a specific underlying asset, like a stock, index, or commodity, is via an option chain, which is also called an options matrix. For that particular asset, it shows the call and put options pricing, strike prices, expiration dates, and other pertinent details.
Option chains offer detailed information about options contracts, such as strike prices, expiration dates, implied volatility, and open interest. Traders utilize this data to create options strategies, mitigate risk, and capitalize on price fluctuations in the underlying asset.
What is the Strike Price?
The strike price on an options contract represents the price at which the underlying security can be bought or sold upon exercise. Options are derivative contracts that give buyers the right to buy or sell a specific security at a predetermined price until a certain date.
What is At the Money (ATM)?
At-the-money (ATM) options refer to calls and puts that have a strike price that is either at or very close to the current market price of the underlying security. Even though ATM options are on the verge of being exercisable, they lack any inherent value. On the other hand, ATM options are frequently employed when a trader anticipates a significant price movement in the underlying asset.
Options that are "at the money" do not have any inherent value and will result in a loss if they are exercised, as the premium paid for the option will not be recovered. However, the ATM is the point at which the option will begin to hold intrinsic value. When the strike price of an option matches the current market price of the underlying asset, it creates a specific scenario.
At the money is a commonly used term in options trading. An ATM situation occurs when the strike price of an options contract matches the current stock price. ATM is one of the three key components of options trading.
What is In the Money (ITM)?
If the market price is above the strike price, then a call option is considered to be in the money (ITM). An option's state of 'moneyness' refers to whether it is in the money (ITM) or not. This is determined by comparing the underlying asset's status to its strike price, which is the price at which it can be bought or sold.
An option that possesses intrinsic value is referred to as "in the money" (ITM). A profitable option is an option that offers a chance to make money based on the relationship between the strike price and the current market price of the underlying asset. When an option is "in the money," it signifies that the option holds inherent value and can be exercised. Nevertheless, the fact that an option is classified as in the money does not guarantee a profitable outcome.
What is Out the Money (OTM)?
Out of the money, or OTM, refers to an option that lacks intrinsic value and is solely dependent on extrinsic value. When the price of an Option has not yet reached its strike price, it is referred to as being out of the money (OTM). Being out of the money is one of the three states of option moneyness. The other two options are in the money (ITM) and at the money (ATM).
OTM options are more affordable compared to ITM options, making them a popular choice among traders with limited capital. When the current market price of the underlying asset is higher than the strike price of the option, the put option is considered out-of-the-money (OTM).
What is a Call Option?
Similar to an auditor, a call is an option contract that grants the owner the right to purchase an underlying security at a predetermined price during a specific period. This contract grants the buyer the option to purchase the asset at a specified price before the contract's expiration date.
Call options are a financial contract that grants the buyer the right, but not the obligation, to purchase a specific stock, bond, commodity, or other asset at a predetermined price within a specified timeframe.
A call option contract usually consists of 100 shares and has an expiration date upon exercise. Investors have the option to either sell or buy underlying assets based on their expectations of price movement. The buyer has the authority to decide whether to exercise the option or let it expire.
What is a Put Option?
Put options provide holders with the right to sell a specified amount of an underlying security at a predetermined price within a designated period, without any obligation to do so. With a put option, you can sell a stock at a specific price (known as the "strike price") before a certain date without being obligated to do so. Before diving into the specifics, it's crucial to have a solid grasp of options.
What are Option trading Strategies?
Options trading may seem complicated, but there are simple strategies for trading in options market that many investors can utilize to increase returns, speculate on market movements, or protect current positions.
Exploring options trading strategies, understanding their potential rewards and risks, and identifying when traders can effectively leverage them for their next investment. Although these trading strategies may seem simple, they have the potential to generate significant profits for traders. However, it's important to note that they come with a certain level of risk.
Types of Option Trading Strategies
There are numerous options trading strategies that one can utilize in the ever-changing market. However, there are approximately three types of strategies for trading in options. Firstly, there are bullish strategies such as the bull call spread and bull put spread. Additionally, there are bearish strategies like the bear call spread and bear put spread. Additionally, there are neutral options strategies available, such as the Long and Short Straddle, Long and Short Strangle, and more.
I have used all these strategies myself, so I would suggest that you also use them and apply them to your trading. Not everyone will agree with all option trading strategies here, but you should understand human nature: everyone thinks differently. However, these strategies are used by investment bankers, so it's worth trying them out.
Strategy 1: Covered Call
A covered call is a commonly employed options strategy that allows investors to generate income when they believe that stock prices are unlikely to experience significant growth shortly. If the stock price remains below the strike price and the option buyer chooses not to exercise the contract, you will retain ownership of the stock and the premium you received.
Advantages of a Covered Call Strategy
- You earn income immediately.
- You potentially lock in a higher price for your investment.
- You get a little downside protection.
Strategy 2: Protective Put Strategy
Investors often utilize a protective put as a valuable risk-management strategy with options contracts. Its purpose is to safeguard against potential losses in stocks or other assets. Investors often choose to buy protective puts on their existing assets to help minimize any potential losses in the future.
Strategy 3: Long Strangle Strategy
An investor buys out-of-the-money calls and put options. Call options have higher strike prices than the underlying asset's market price, whereas put options have lower strike prices. This means that the strategy costs less to start, but the stock will have to move more in either way for you to make money.
Strategy 4: Long Straddle Strategy
An options strategy involves purchasing both a long call and a long put on the same underlying asset, with the same expiration date and strike price. An options trading strategy involves purchasing both a call option and a put option with the same strike price and expiration date.
Strategy 5: Bull Call Spread Strategy
A bull call spread is a popular options strategy employed by traders who anticipate a modest rise in the price of an asset. This strategy restricts potential losses to the net debit paid and limits gains to the difference between strikes.
Strategy 6: Bear Put Spread Strategy
An options strategy called a bear put spread can be used by investors who have a bearish outlook and want to minimize losses while maximizing profit. There is a limit to the profit if the stock price goes below the strike price of the short put (lower strike), and there is also a limit to the potential loss if the stock price goes above the strike price of the long put (higher strike). A bear put spread strategy entails buying and selling puts for the same underlying asset, with the same expiration date but at different strike prices.
Strategy 7: Iron Condor Strategy
An iron condor is a strategy used in options trading that tends to generate the highest profits when the underlying asset remains relatively stable. However, it is possible to adjust the strategy to have a more optimistic or pessimistic outlook. This strategy, known as the iron condor, offers a way to potentially benefit from low volatility in the underlying security. It is a limited-risk, limited-profit approach that can be advantageous when the strategy is active.
Strategy 8: Butterfly Spread Strategy
An options strategy known as a butterfly spread combines elements of both bull and bear spreads. This strategy is considered advanced due to the relatively low-profit potential in terms of dollars and the high associated costs. The symmetrical structure is a key characteristic of the long call butterfly spread.
Strategy 9: Calendar Spread Strategy
A calendar spread is a strategy in derivatives that involves purchasing a contract with a later expiration date and selling a contract with an earlier expiration date. As an example, you could consider buying a call option with a strike price of 100 for two months and simultaneously selling a call option with the same strike price of 100 for one month. With a debit position, payment is required upfront for the trade.
Strategy 10: Iron Butterfly Strategy
Iron butterfly trades can be a profitable strategy for capitalizing on price movement within a limited range when implied volatility is decreasing. The iron butterfly, modified butterfly, and condor spread are part of a group of option strategies referred to as "wingspreads."
Conclusion
These option trading strategies have been developed by highly professional hedge fund managers after years of knowledge and experience, allowing them to minimize their losses as much as possible. Options trading is not rocket science; you just need knowledge of the best strategies so that you can adapt them to your situation in the market.
These are some of the best strategies for options trading you can follow to get the best outcome for your trades.
