Best Options Trading Strategies For Investors

Larry Davidson - August 3, 2018

Trading options can create an added dimension to your overall trading. Some options trading strategies will offer greater flexibility, and better risk/reward than trading the underlying stock.

You see, when you’re trading stocks you are betting that the stock price rises ( long) or falls (short). But with options, you can bet that the price of a stock will rise, drop, stay in a range, experience high or low volatility, and a whole lot more.

It’s this type of versatility that attracts investors into trading options.

Basic Options Trading Strategies – Calls

Before we dive into options trading strategies it’s important you know some key terms. There are two types of options, calls, and puts.

Call Option: A contract that provides the buyer the right to purchase a predetermined amount of stock at a specific price and date.

One option contract represents 100 shares of stock. For example, if you owned 10 call options of General Electric, you would have the right to convert those to 1000 shares of stock.

At the time of this writing, General Electric stock is trading around$15 per share. January 17, 2020, $15 calls are trading for $2.40 per contract.

What does this all mean?

Well, if you bought these calls you are saying that you’re willing to buy GE stock at $15 per share. You are paying $240 per contract ($2.40 x 100 shares), in order for you to break even at expiration (January 17, 2020) you’ll need GE to be trading above $17.40 per share ($15 + $2.40 premium).

Now, if the stock never gets to that price level by expiration, the options will be worthless. Whenever you buy an option, the risk is limited to the amount of premium you spend on the contract.  In other words, if General Electric would to hypothetically go bankrupt, the only risk the call buyer is exposed to is the cost of their options contracts.

Buying a call option is another way to get bullish on a stock without actually buying the underlying.

On the other hand, the seller of a call option has the same risk profile as a trader who is naked short a stock, undefined. Shorting calls naked is not suitable for most investors because it is risky, potentially leading to losses greater than the funds in your trading account.

Basic Options Trading Strategies – Puts

Calls are used to express a bullish view, and traders buy puts when they are bearish on the underlying stock.  They could also be used as a way to hedge and have downside protection if you are long the underlying stock.

Put Option: A contract that provides the buyer the right to sell a predetermined amount of stock at a specific price and date.

For example, if the SPDR S&P 500 ETF (SPY) is trading at 280. The $280 puts expiring in a week are trading for $1.00.  If the trader buys these puts it will cost them $100 per option contract. The way they make money is if the SPY drops below 279 before expiration.  The great thing about buying put options vs. selling a stock short, long puts are a defined risk strategy, whereas, selling a stock short has undefined risk.

options trading strategies

Buying puts can be used to speculate on the future decline of company stock or ETF. They could also be used to hedge a long portfolio against the market downside. For example, if you have a basket of stocks as part of your long-term retirement portfolio, consider buying index fund puts like SPY.

Of course, you could also buy puts to hedge an individual stock position. Let’s say a stock your long has upcoming earnings and are uncomfortable with anticipated volatility. By buying a put option you can limit your risk while maintaining your upside profit potential.

Buying puts as a way to hedge is like buying medical insurance. You pay a premium but hope that you’ll never need it. But if an emergency strikes you’re glad that you are covered.

Best Options Trading Strategies- For Investors

One of the craftiest ways to express a bullish bias on a stock before owning it is by selling naked puts. Now, if buying puts is considered a bearish strategy than selling puts is considered a bullish strategy.

The above image is an example of the type of put option an investor might sell. These options are more than $40 out-of-the-money and are expiring in a little less than a years time.

If a trader sells these $150 puts in Apple, they will receive a premium of $4.01. They’ll be able to keep that entire premium if the stock stays above $150 on the expiration date.

Why is this such a great long-term strategy?

Because you’re able to profit off the stock’s uptrend for cheap. However, the long-term investor ultimately wants to buy the underlying stock.

The investor is willing to buy Apple shares at $150 per share by expiration. They receive $401 per contract for taking on the risk. If Apple stays put or trends higher, the investor retains the premium received.  The investor can repeat the strategy for as long as it matches their thesis.

For the long-term investor, this is very much a win-win scenario for them.

Selling puts naked requires an investor to have a margin account. It’s important that investors respect the leverage of options and don’t put themselves in a position where they could receive a margin call.

Bottom Line

The best option strategy is the one that best matches your opinion. Since options don’t move up and down the same way stocks do, it’s important that you learn about how they are priced. Specifically, understanding the role that time, and volatility have on the price of an option.

In periods of low volatility, you want to be a buyer of options. In periods of high volatility, you want to be a seller of option premium. Looking at charts of historic volatility is just as important as price charts if you want to trade options.

Selling puts naked in a stock you might be one of the best options strategies for long-term investors. It’s not the most lucrative but it’s very solid way to generate revenue from your holdings

Larry D. is one of the most experienced writers at the Dork. His expert insights into the individual stocks have made small fortunes for some of his readers and profitable trades for many more. Best known for his work with under-the-radar growth stocks, Larry has been picking winners for over 30 years.

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