The first opinion more investors have of stock options is that of fear and bewilderment. Contrary to belief, what most investors fail to appreciate is that stock options are suitable securities for investors interested in conservative, income-generating schemes. Investors looking for the safest trading strategy to use would certainly need to take options into account.
Options are useful tools for trading and risk management. However, using the right strategy is key to its success. It is imperative to understand what stock options are and how they do operate to get the right strategy. The safest option trading strategy is one that can get you reasonable returns without the potential for a huge loss.
An option offers the owner the right to buy a specified asset on or before a particular date at a particular price. Stock investors have two choices, call and put options. A call options give the holder the right to buy a financial instrument while a put option gives the owner the right to sell.
Options have been used to hedge existing positions, predict the direction of volatility, and initiate play. Furthermore, options do assist in helping investors to establish the specific risk they have taken in a particular position.
The primary idea behind options lies in the strategic use of leverage. Investors ought to be systematic in their choice of strategy. The better options strategy to employ should always be determined by the general market opinion and what the investor’s goals are. The following are some of the best options strategies in the market.
The covered call strategy is also called a buy-write. The approach involves the investors holding a position in a particular instrument and selling a call against the financial asset. The investor’s market opinion should be bullish towards that similar instrument.
This strategy limits the maximum profits that may be made by the investors while the losses remain quite substantial. Volatility affects the outcome since while volatility increases the effects are negative. The reverse condition is also true.
Once the underlying asset moves against what the investor anticipated, the short call can offset a considerable amount of the losses. Often, knowledgeable traders employ this strategy so as to match the net returns with reduced market volatility. This approach is particularly friendly for beginners since it enables its users to limit volatility in a particular position.
Covered calls are viewed widely as a most conservative strategy. Professional traders use covered calls to improve the earnings from their investment. Covered call strategies can offset risk while adding returns. Additionally, investors can use covered calls as means of decreasing their cost basis even when the securities themselves do not pay dividends.
Bull and bear spreads
Bull call and bear put spreads are commonly known as vertical spreads. This is because the two occur within the same month. Moreover, they both have two different strikes. Contrary to the covered call option, the bull and bear spreads strategies quantifies the investor’s risks more easily.
The bull call spread strategy involves the investor buying a call option on an underlying asset while also selling a call on the same asset at the same time. Additionally, both options have similar expiration months only at a higher strike price. This option should be employed when the employer has a bullish opinion of the market in future. This should mean that the investor hopes the market will go up. The bull call spread strategy limits profits as well as the risks associated with a given asset.
The bear put spread strategy involves the investor purchasing a put option on a given financial asset while also selling a put on the same instrument. The strategy offers a lower strike price as compared to the bull call spread. Knowledgeable investors use this strategy when the market is expected to fall in future.
A calendar spread strategy involves the investor establishing a position. This is done by the trader simultaneously getting into a long and short position on the same asset, but with varying delivery months.
The primary idea behind this strategy is that as expiration dates get closer, time decay is evidenced more quickly. The point is once the investor shorts the front-month option, he or she has an evaporating time premium. The time premium evaporates faster than the decay time in the out option. Just as in the call and put spreads, the investor is technically paying for the spread. The more out of time he or she goes, the bigger the payment is.
In calendar spreads, the further out of time the investor goes the more volatility the spread is. In case the investor picks an at the money strike, the underlying asset will have to lie around the strike for this technique to work. If the investor selects an out of the money strike and a high spread, the underlying asset has to go up. Moreover, traders picking an in the money strike hope that the underlying asset will go down.
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