Options Trading Strategies
There are many ways in which an investor can invest his/her money in different asset classes. Options trading is one of the asset classes when you are looking beyond stocks, mutual funds, or bonds. Options can be very helpful if they are used in the right way. Here in this article, we are going to study what are options? And also major option trading strategies.
What is Options Trading?
Options trading is the trading of contracts that gives the buyer a right to buy or sell an asset at a predetermined price until the contract ends or on the day of expiry. Options are traded for two main reasons one is speculating and the other one is hedging.
Now we will see Types of Options
|Type of option||How does it work?|
|Call||It gives the right to buy the stock in future|
|Put||It gives the right to sell the stock in future|
Here we are going to discuss some of the option strategies available to avail high reward with low risk.
- Bull Call Spread
A bull call spread is a bullish strategy. This strategy includes both buying and selling of call options. One has to buy a call option by paying a premium at one strike price and sell another with a higher strike price with the same expiry and collect the premium. This strategy helps to limit losses and it also limits our profit.
By selling another call option helps to cover our premium back. This type of strategy is used when one thinks that there will be a moderate rise in value because it also caps profits. Profits are capped to the difference between both of the strike prices of call options minus the net premium paid. (Paid for first call option (buying) - Gained from second call option (selling))
- Covered Call
This options strategy is for those who already have security in their Demat account. In this strategy, investors sell the call option of the stock which he/she owns and have it in the Demat account. This is a bullish strategy. One should sell the call option of the strike price above the spot price.
This type of strategy works fine until the stock price is below the strike price because one earns the premium and can also earn the profit on stocks, but if the stock’s current market price is higher than the strike price, it will limit your profit. This strategy is for those who are long on the share and ready to invest more, even if it goes below.
- Call Ratio Back Spread
This is one of the bullish options strategies. This strategy involves buying a higher number of calls at a higher strike price than and selling of calls having the same expiry. There should be more number of buying of calls than selling of calls. The long to short ratio can be 5:3, 2:1, 3:1. This strategy can have unlimited upside potential, the reason is people have more long calls at higher strike prices than short calls which are at lower strike prices.
Loss can only happen when market or share range bounds between the upper and lower strike price and also up to above higher strike price at some level. When the market will be lower than the lower strike price then there will be limited profits and if it’s above the upper strike price after a certain level then there is the possibility of unlimited profits
- Bear Put Spread
The trader has to buy and sell the put option with the same strike price and expiry of the same underlying asset while selling at a lower strike price. This is a bearish strategy when a trader expects the asset prices to decline. Using this strategy will lead to limited losses and limited gains. This strategy is for conservative traders.
This strategy includes
1. Buying in the money put option
2. Selling an Out of the Money Put Option.
- Long Strangle
This is one of the option trading strategies used by the traders when they don’t know in which direction the sentiments will move for an asset, like a declaration of earnings, Approval of Foods, or Drugs results. Traders have to purchase out of the money put at the lower strike price and call option at higher strike price of the same underlying asset with the same expiry. It will have limited losses up to the premium paid for it. Traders will be in profit only if there is huge movement on either side, bullish or bearish.
These are the few option strategies, there are many available to maximize reward and reduce risk as possible. There are many other option trading strategies available. This article is an introduction to option trading strategies.