Too often, traders jump into the options game with little or no understanding of how many options strategies are available to limit their risk and maximize return. With a little bit of effort, however, traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction.
Aside from purchasing a naked call option, you can also engage in a basic covered call or buy-write strategy. In this strategy, you would purchase the assets outright, and simultaneously write or sell a call option on those same assets. Your volume of assets owned should be equivalent to the number of assets underlying the call option.
Investors will often use this position when they have a short-term position and a neutral opinion on the assets, and are looking to generate additional profits through receipt of the call premium , or protect against a potential decline in the underlying asset's value.
For more insight, read Covered Call Strategies For A Falling Market. 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: 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.
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To learn more, read Vertical Bull and Bear Credit Spreads. 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. A protective collar strategy is performed by purchasing an out-of-the-money put option and writing an out-of-the-money call option at the same time, for the same underlying asset such as shares.
This strategy is often used by investors after a long position in a stock has experienced substantial gains. In this way, investors can lock in profits without selling their shares.Call Options & Put Options Explained Simply In 8 Minutes (How To Trade Options For Beginners)
For more on these types of strategies, see Don't Forget Your Protective Collar and How a Protective Collar Works. 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.
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. All the strategies up to this point have required a combination of two different positions or contracts. In a butterfly spread options strategy, an investor will combine both a bull spread strategy and a bear spread strategy, and use three different strike prices.
For example, one type of butterfly spread involves purchasing one call put option at the lowest highest strike price, while selling two call put options at a higher lower strike price, and then one last call put option at an even higher lower strike price. For more on this strategy, read Setting Profit Traps With Butterfly Spreads.
An even more interesting strategy is the i ron condor. In this strategy, the investor simultaneously holds a long and short position in two different strangle strategies. The iron condor is a fairly complex strategy that definitely requires time to learn, and practice to master.
We recommend reading more about this strategy in Take Flight With An Iron Condor , Should You Flock To Iron Condors? 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 a 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. To learn more, read What is an Iron Butterfly Option Strategy? Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund.
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Proven Trading Strategies for Indian Markets
A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price. Learn why option spreads offer trading opportunities with limited risk and greater versatility. Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons. Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
Stocks are not the only securities underlying options. Learn how to use FOREX options for profit and hedging. If you want to take advantage of the versatility of options, you'll need to adopt these smart investing habits.
Profitable Option Trading Strategies for Any Market Environment
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