Options trading can be very lucrative for a switched on investor. With the right strategies, you will be well on your way to achieving your options’ goals. This article will run over different strategies that you can implement in your own options trading. Some of these strategies will help you to protect your stock investments; other strategies will require no stock and just use options to generate profits. The six strategies covered are covered call, married put, bull call spread, bear put spread, long straddle and long strangle. You will also see some examples so you can gain a better understanding of how these strategies work. By the end of this article, you will have an excellent understanding of 6 options strategies that you should know.
1. Covered Call
This strategy entails issuing a call option on shares you have recently purchased or already own. If you engage in the covered call strategy, you would acquire enough call options to cover the shares that you own. For example, if you have 10,000 shares in XYZ, you would issue 100 call options, as this would equate to your 10,000 shares.
You would use this strategy if you thought the price of your stock would not increase much and wanted to earn some extra profits. By employing the covered call strategy, you be able to pocket the premium that the option buyer pays for your call options. This means this strategy is great for short-term gain.
One thing to keep in mind is that the chance for profit is limited. You will gain income from the premium the buy pays for the options, however, if the stock price increases to a price above the strike price, the option holder will exercise the options. You will need to sell the stock at the strike price to the owner.
2. Married Put
You should think of this strategy as an insurance policy against falling stock prices. The married put strategy entails an investor purchasing put options on shares of stock they already own. Basically, the investor would use this as a safety net in case the price of this stock dropped too much. Instead of having to sell the stock at market price, the option holder could exercise the options and sell the stock at the higher strike price.
In the married put strategy, the owner would have to purchase enough put options to cover the same amount of a specific stock they owned. For example, if the investor owned 5000 shares of ABC, they would need to purchase 50 put options to cover their ABC stock. This is more expensive in the short term as the investor would need to pay the premium for the put options to cover the stock.
The married put strategy can be used as insurance for any stock. However, it is usually used on risky stock to ensure losses are minimized. The put options ensure the stock can be sold at the strike price and not the plummeting market price.
3. Bull Call spread
If you were to employ the Bull Call Spread strategy, you would buy call options at one strike price and also sell call options at a higher strike price. These options would all be for the same stock and the same amount of stock, and all of these options would need to have the same expiry date. So when the call options you sold were exercised, you would exercise the call options you bought to provide the stock you needed to provide.
Is this confusing for you? Let’s take a look at an example. If you bought call options for 1000 shares of XYZ stock, you would also sell call options for 1000 shares of XYZ stock. The call options that you bought could have a strike price of $25 and the call options you sold could have a strike price of $27.
If the market price increases above $27 dollars, the call options you sold would be exercised. When this happens, you would exercise the call options you bought with a strike price of $25. After buying the 1000 shares at $25 dollars, you would turn around and sell them to the investor who bought the call options from you. This would mean that you make $2 per share equating to $2000. Keep in mind there will be premiums to be paid and possibly brokerage fees.
This strategy is a great way to profit from shares you don’t own. You can make investments for the price of the premiums instead of having to risk your capital by purchasing stock.
4. Bear Put Spread
If you enact this strategy you would buy put options at one specific strike price and then also sell the same number of put options at a lower strike price. These options would all be for the same stock, the same amount of stock and all of these options would need to have the same expiry date. Basically, when the market price would drop below the strike price for the put options you sold, the holder of those options would choose to exercise them. When this happens, you would exercise the put options you were holding in order to sell the stock at the higher strike price.
Here is an example. If you bought put options for 1000 shares of ABC stock, you would also sell put options for 1000 shares of ABC stock. The put options that you bought could have a strike price of $5 and the call options you sold could have a strike price of $4.
If the market price decreases below $4 dollars, the put options you sold would be exercised. When this happens, you would exercise the put options you bought with a strike price of $4. After being sold the 1000 shares at $4 dollars, you would turn around and sell them to the investor who bought the put options from you. This would mean that you make $1 per share equating to $1000. Keep in mind there will be premiums to be paid and possibly brokerage fees.
This Strategy does not involve much risk but will also not make you rich. Think of it as the reverse of the Bull call spread.
5. Long Straddle
This strategy entails buying call and put options for the same stock at the same strike price. The calls and puts would need to be for the same duration and same stock. The calls and put would need to be for an equal number of shares.
For example, you could buy 100 put options and 100 call options at a strike price of $10. If the market price fell to $2, you could buy 10,000 shares at this price and then exercise your put options. This would mean that you could sell the shares you just bought for a profit of $8 per share. This would mean a profit of $80,000.
Another scenario might see the market price go to $15 dollars. You could then exercise your call options to buy 10,000 shares at $10. You would then sell them at the market price of $15.
Obviously, you could see substantial profits with this strategy, however, the market price would need to differ significantly from the strike price to make this strategy worth while. Usually, you would employ this strategy if you thought that the market price was going to move significantly but you didn’t know which way it would move. You can make some serious profits with this strategy while the only capital you risk losing is the cost of the premiums.
6. Long strangle
If you were to employ the long strangle strategy, you would use both call and put options. This is similar to the long straddle that you have previously mentioned, however, in the long strangle strategy, you would purchase these the call options and put options at different prices. The options will be in the same stock and have the same duration.
Traditionally, you would purchase these options for prices that are “out of the money.” The term “out of the money” means that the price is less desirable than the market price. For example, a call option that is “out of the money” would have a strike price that is higher the market price. This would mean that if you exercised the option you would have to pay a higher price than the market price. Obviously, this isn’t a great idea.
On the other hand, a put option that is “out of the money” would be an option with a strike price that is lower than the current market price. This would mean that if you exercise the option, you would have to have to sell your stock at a price lower than what the market is offering. Obviously, you would not want to do this.
You might be wondering, why would anyone want options that are “out of the money.” The answer is a simple one: the premium you pay is cheaper. This means that “out of the money” options will be less risky in terms of investment.
Now that we have covered “out of the money,” you can see that the long strangle strategy is very similar to the long straddle strategy with one key difference; the long strangle strategy uses “out of money options.” You would use this strategy if you thought the market price would move drastically but you didn’t know which way it would move.
For example, the market price for XYZ stock could be $15. You could buy call options for $17 and put options for $13. If the market price increased above $17, you would exercise your call options and then sell the stock on the market. If the market price dropped below $13, you could buy stock at the lower market price and then you could exercise your put options to sell for the higher strike price.
While the long straddle and long strangle strategies seem similar, you would use the long strangle strategy when you thought the market price would move more drastically. The market price would need to move outside of the strike prices you have in the call or put options. If you thought the movement of the market price would not be that drastic, you would use the long straddle. The long straddle will have more expensive premiums than the long strangle would have. While the only risk you have with each strategy is losing the cost of you premiums, you will lose less money with the long strangle strategy as the cost of the premiums would be cheaper than the long straddle strategy.
Now you are ready to take the next step of your options trading journey. You now know six options trading strategies to get you off to a flying start on the road to reaching your goals. We have covered the covered call and married put strategies, which will give you an advantage of stock you already own or are going to buy. The bull call spread and bear put spread strategies are great when you think there will be a stock price movement in a specific direction. You can implement these two options strategies with a low risk exposure, as you will only lose the premiums you paid for the options.
Finally, you have learnt two more low risk strategies. The long straddle and the long strangle are perfect for scenarios where you think there will be a market movement but you are not sure whether the price will increase or decrease. Now you are ready to use one or more of these options trading strategies in your own portfolio. When you implement these strategies at favourable times, you’ll see some great outcomes that will protect your investments or give you some great profits.
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