Options Strategy Every Option Trader Must Know
Options strategy is the simultaneous, and often mixed, buying or selling of one or more options that differ in one or more of the option variables.
In layman’s language – Call Option – Upside Betting and Put Option – Downside Betting.
Call options, simply known as calls, gives the buyer a right to buy a particular stock at that option’s strike price. Conversely, put options, simply known as puts, give the buyer the right to sell a particular stock at the option’s strike price. This is often done to gain exposure to a specific type of opportunity or risk while eliminating other risks as part of a trading strategy.
A very straightforward strategy might simply be the buying or selling of a single option, however option strategies often refer to a combination of simultaneous buying and or selling of options which is basically done to earn gains or to hedge the risk involved in portfolio.
Options strategies allow traders to profit from movements in the underlying assets based on market sentiment (i.e., bullish, bearish or neutral). In the case of neutral strategies, they can be further classified into those that are bullish on volatility, measured by the lowercase Greek letter sigma (σ), and those that are bearish on volatility. Traders can also profit off time decay, measured by the uppercase Greek letter theta (Θ), when the stock market has low volatility. The option positions used can be long and/or short positions in calls and puts.
Option traders are often eager to begin trading – too eager. It’s important to get a solid foundation to be certain that you understand how options work and how they can help you achieve your goals – before trading. So here are the 11 option strategies for option traders:-
1. Covered call writing:- Using stock you already own (or buy new shares), you sell someone else a call option that grants the buyer the right to buy your stock at a specified price. That limits profit potential. You collect a cash premium that is yours to keep, no matter what else happens. That cash reduces your cost. Thus, if the stock declines in price, you may incur a loss, but you are better off than if you simply owned the shares.
2.Married Put:- In a married put strategy, an investor who purchases (or currently owns) a particular asset (such as shares), simultaneously purchases a put option for an equivalent number of shares. Investors will use this strategy when they are bullish on the asset’s price and wish to protect themselves against potential short-term losses. This strategy essentially functions like an insurance policy, and establishes a floor should the asset’s price plunge dramatically. (For more on using this strategy, see Married Puts: A Protective Relationship.)
3.Cash-secured naked put writing:- Sell a put option on a stock you want to own, choosing a strike price that represents the price you are willing to pay for stock. You collect a cash premium in return for accepting an obligation to buy stock by paying the strike price. You may not buy the stock, but if you don’t, you keep the premium as a consolation prize. If you maintain enough cash in your brokerage account to buy the shares (if the put owner exercises the put), then you are considered to be ‘cash-secured.’
4.Bull Call Spread:- In a bull call spread strategy, an investor will simultaneously buy call options at a specific strike price and sell the same number of calls at a higher strike price. Both call options will have the same expiration month and underlying asset. This type of vertical spread strategy is often used when an investor is bullish and expects a moderate rise in the price of the underlying asset. (To learn more, read Vertical Bull and Bear Credit Spreads.)
5.Collar:- A collar is a covered call position, with the addition of a put. The put acts as an insurance policy and limit losses to a minimal (but adjustable) amount. Profits are also limited, but conservative investors find that it’s a good trade-off to limit profits in return for limited losses.
6.Bear Put Spread:- The bear put spread strategy is another form of vertical spread like the bull call spread. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price. Both options would be for the same underlying asset and have the same expiration date. This method is used when the trader is bearish and expects the underlying asset’s price to decline. It offers both limited gains and limited losses. (For more on this strategy, read Bear Put Spreads: A Roaring Alternative to Short Selling.)
7.Credit spread:- The purchase of one call option, and the sale of another. Or the purchase of one put option, and the sale of another. Both options have the same expiration. It’s called a credit spread because the investor collects cash for the trade. Thus, the higher priced option is sold, and a less expensive, further out of the money option is bought. This strategy has a market bias (call spread is bearish and put spread is bullish) with limited profits and limited losses.
8.Long Straddle:- A long straddle options strategy is when an investor purchases both a call and put option with the same strike price, underlying asset and expiration date simultaneously. An investor will often use this strategy when he or she believes the price of the underlying asset will move significantly, but is unsure of which direction the move will take. This strategy allows the investor to maintain unlimited gains, while the loss is limited to the cost of both options contracts. (For more, read Straddle Strategy a Simple Approach to Market Neutral.)
9.Long Strangle:- In a long strangle options strategy, the investor purchases a call and put option with the same maturity and underlying asset, but with different strike prices. The put strike price will typically be below the strike price of the call option, and both options will be out of the money. An investor who uses this strategy believes the underlying asset’s price will experience a large movement, but is unsure of which direction the move will take. Losses are limited to the costs of both options; strangles will typically be less expensive than straddles because the options are purchased out of the money. (For more, see Get a Strong Hold on Profit with Strangles.)
10.Iron Butterfly:- The final options strategy we will demonstrate here is the iron butterfly. In this strategy, an investor will combine either a long or short straddle with the simultaneous purchase or sale of strangle. Although similar to a butterfly spread, this strategy differs because it uses both calls and puts, as opposed to one or the other. Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors will often use out-of-the-money options in an effort to cut costs while limiting risk.
11.Diagonal (or double diagonal) spread:- These are spreads in which the options have different strike prices and different expiration dates. The option bought expires later than the option sold. The option bought is further out of the money than the option sold. If you own both positions at the same time, it’s a double diagonal spread.
Note – Trading in Future & Options is for high risk appetite traders, Beginners must have an in-depth knowledge and study of market before trading in F&O. It is advisable to trade in Future & Options with strict Stop loss & proper discipline.
Benjamin Graham has wisely said that traders gets a thrill while speculating and often the thrills of Wall Street are quite expensive.
If you are new to the world of investing then here is the advice by the – Most Successful Value Investor and Billionaire Warren Buffett.
He said that the best advice he got was from his holy bible, The Intelligent Investor, written in 1949 by value god Benjamin Graham. He further said that, “Chapters 8 and 20 have been the bedrock of my investing activities for more than 60 years,” he says. “I suggest that all investors read those chapters and re-read them every time the market has been especially strong or weak.” – Download
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