Last updated on: October 25, 2023
Traders sometimes begin trading options without having a thorough grasp of the various options techniques at their disposal. There are various ways available that can both reduce risk and increase profit. Traders may learn how to benefit from the flexibility and power that stock options can offer with a little effort.
Options trading may appear complicated, but there are several fundamental techniques that the majority of investors may apply to increase profits, predict market movement, or hedge current positions. When you already own a stake in the underlying shares, covered calls, collars, and married puts are employed. Spreads require simultaneously selling one option while purchasing one (or more) options (or options). Strangles and long straddles make money when the market moves up or down.
The purpose of options trading is to minimize losses and maximize profits by purchasing calls or puts, selling calls or puts, or doing both at once. Using a mixture or combinations to achieve the optimum result depending on our predetermined criteria. Put options offer the owner the right, but not the responsibility, to sell the underlying stock at a predetermined price by a certain expiration date, whereas call options allow the holder the right, but not the obligation, to acquire the underlying stock.
There are 3 categories of option trading strategies: bullish, bearish, and neutral. Sounds intriguing up to this point? Well, there’s more to pique your interest. These are a few:
The naked call option can be used as a tactic for calls. Additionally, you may set up a basic covered call or buy-write. This is a common approach since it produces income and lowers some of the risk associated with holding a position in a single asset. The trade-off is that you have to be prepared to sell your shares at the short strike price, which is a predetermined price. To carry out the approach, you buy the underlying stock as usual while also writing—or selling—a call option on the same shares.
When an investor has a short-term holding in the stock and a neutral view of its future course, they may decide to employ this technique. They could be trying to make money by selling the call premium or hedging against a possible decrease in the value of the underlying stock.
2.Bull Call Spread
One bullish option strategy involves buying one call option that is At-The-Money (ATM) and selling the call option that is Out-Of-The-Money. This is known as a bull call spread. It is important to keep in mind that both calls must have the same underlying stock and expiration date.
With this technique, gains are realized when the price of the underlying stock rises, which is equal to the spread less the net debit, and losses are experienced when the stock price declines, which is equal to the net debit. An individual pays a lower strike premium less than an individual receives a higher strike premium on a net debit basis. The difference between the higher and lower strike prices is referred to as the spread.
Bull Call Spread provides protection when prices decline and also has a cap on the profit. When option traders are slightly positive on the direction of the underlying asset, they might use the bull put spread as one of their bullish options strategies. This tactic is comparable to the bull call spread, except that we’re purchasing puts instead of calls. Using this approach, you would purchase 1 OTM put option and sell 1 ITM put option. It’s important to remember that both puts must have the same underlying stock and expiration date. In contrast, the possible loss is restricted and happens when the stock price drops below the long put’s strike price. A bull put spread is created for a net credit, or net amount received, and it incurs benefit from an increasing stock price that is limited to the net credit received.
3.Bear Put Spread
Another type of vertical spread is the bear-put spread method. In this approach, the investor buys a certain number of put options at a certain strike price while concurrently selling an equal number of puts at a lower strike price. Both options have the same expiration date and are bought for the same underlying asset. 2 When a trader is negative on the underlying asset and anticipates a decrease in the asset’s price, they will adopt this approach. The technique provides modest benefits and losses. Using the Bear Put Spread approach, the ITM Put option is purchased, and the OTM Put option is sold. It is important to keep in mind that both puts must have the same underlying stock and expiration date. This tactic is created for a net debit or net cost and earns money as the price of the underlying stock declines.
An out-of-the-money call option and an out-of-the-money put option are simultaneously purchased on the same underlying asset with the same expiration date in a long strangle options strategy by the investor. This approach is employed by an investor who anticipates a very significant change in the price of the underlying asset, but who is unclear of the direction in which the movement will occur.
This tactic can involve betting on information from a firm’s earnings announcement or an occurrence connected to the Food and Drug Administration’s (FDA) approval of a stock in a pharmaceutical company. Losses are strictly confined to the premiums paid for both choices, or their expenses. Because the acquired options are out-of-the-money options, strangles are usually always less expensive than straddles.
The investor owns both a bull put spread and a bear call spread when using the iron condor technique. The bull put spread and the bear call spread is used to create the iron condor. The bull put spread is created by selling one out-of-the-money (OTM) put and purchasing one OTM put of a lower strike.
All of the options are based on the same underlying asset and have the same expiration date. Usually, the spread widths on the put and call sides are equal. This trading method is made to profit from a stock with less volatility and generates a net premium on the structure. This method is popular among traders because they believe it can produce a tiny premium.
An investor will sell an at-the-money put and purchase an out-of-the-money put when using the iron butterfly approach. They will also sell at-the-money calls and purchase out-of-the-money calls at the same time. All of the options are based on the same underlying asset and have the same expiration date. Although this tactic includes both calls and puts, it is akin to a butterfly spread (as opposed to one or the other).
Essentially, this tactic sells an at-the-money straddle and purchases safety “wings.” Two spreads can also be used to describe the design. It is typical for both spreads to be the same width. The lengthy, out-of-the-money call hedges against all potential losses. In the case of an out-of-the-money long put, there is protection from losses (from the strike of the short put to zero). Profit and loss are constrained to fall within a particular range depending on the strike prices of the deployed options. Due to the income it produces and the better likelihood of a little gain with a non-volatile stock, investors like this method.