Great fortunes have been made in the stock market trading options. It’s not surprising then that a whole legion of traders and investors are constantly trying to find the best options trading strategies. As with most things stock market, it helps to have a thorough grounding in the fundamentals; it’s a bit like making sure you understand musical scales before you attempt to compose a concerto. Knowing the underlying fundamentals of options will help you to utilize the five options trading strategies we’ll outline below.
Options Trading Strategies – What Are Options?
An option is the right to buy or sell a security at some point in the future. This security can be anything that is tradable in the market place. It could be a stock, Forex, you name it; so long as there is a market for it, you can either buy or sell an option for it. It is important to note that the option is decoupled from the asset itself; the former is more or less always executed upon in the present state while the latter is executed upon at some point in the future.
Options come in two flavors: call and put options. A call option gives the buyer of the contract the right to purchase the underlying security at some point in the future at a preset price. This preset price is called the strike price or exercise price. A put option works in the opposite way, giving the buyer of such a contract the right to sell an underlying security at a fixed date in the future.
Fine and dandy so far, but what about risk? This is where these five options trading strategies come in because options, by their nature, are riskier propositions than say buying stocks upfront. The main reason for the risk is that when you buy a stock, assuming the company stays afloat, you can hold onto that investment for as long as you want. Options don’t give that time-flexibility; when the agreed upon date for their execution arrives, they expire. This is an important principle to bear in mind as you explore these five options trading strategies.
Options Trading Strategies – The Covered Call
Let’s say you believe that a stock will be increase lightly in the future but at the same time you want to sacrifice some of that upside whilst limiting your downside. In a such a scenario, you’d create a short position in the call position, whilst simultaneously creating a long position in the underlying asset. This strategy shifts the burden of risk to the call writer (the party from which you choose to purchase the call option), thereby minimizing your downside risk.
Options Trading Strategies – Protective Put
You won’t always be looking to trade options from the perspective of a buyer. Often you’ll be looking to minimize risk as a seller and this is where the protective put options trading strategy comes in handy. This strategy helps to minimize downside risk. It involves holding a long position in the underlying asset as well as maintaining a long put option position. Dubbed the ultimate insurance strategy for trading put options, the strategy helps the seller to hold onto underlying assets that expire under option. This strategy also assumes that the price of the underlying asset doesn’t decrease in value beyond the expiration date of the initial contract. When that happens the seller is stuck with expired options as well under-performing assets and this for obvious reasons, isn’t any good.
Options Trading Strategies – The Long Call
When buying calls a good strategy to use is the long call. This is handy when you are bullish on a particular security or believe that the markets will increase in activity thereby benefiting underlying players in the market. Long calls allow the buyer to leverage the buying of assets at a discount since the actual trading price of say a stock; will not be the agreed contract price for the call option. This is a future dating of a stock’s price and a very clever way to get in the game without risking a whole lot upfront.
Options Trading Strategies – The Long Put
Let’s say you believe that the underlying return on an asset will decrease in value but you also don’t want to risk anything big on a short strategy. In other words, you believe something is going down, but you don’t want to bet too heavily on it. In such an instance you are best served utilizing the long put strategy. This strategy lets you bet safely against a stock going down, only risking the premium placed on the initial contract as a downside. The long put is one of the safer, more risk-averse ways to be bearish without out and out shorting a stock.
Of course finding the best opportunities for options is not the easiest thing which is why it helps to have a trusted advisor. In this case you can do no better than signing up to a credible newsletter. This one is a very good place to start. Check them out.