Options Trading Strategies

A lot of people who trade options do so without fully knowing the different strategies they can use. There are a lot of options strategies that can help you reduce risk and make the most money. If you put in a little work, you can learn how to use the power and freedom that stock options offer. We discover the top Options trading strategies to boost profits.

What are Options?

Option contracts give an investor the choice to buy or sell shares at a certain price at any time before the contract ends.

Most option contracts cover 100 shares of the company. For example, if you get the right to buy Apple stock at a certain price, that's 100 shares of the company.

Consider that these contracts are different from stock options offered by employers.

Let’s take a look at some options strategies that traders should know when trading in options.

Bull Call Spread

A trader uses a bull call spread strategy when they buy calls at a certain strike price and sell the same number of calls at a higher strike price at the same time. Both call options will expire on the same day and be based on the same asset.

People who are bullish on the underlying asset and think its price will go up slightly often use this type of vertical spread approach. Traders who employ this strategy acknowledge a limited profit potential. The trade costs them less cash than other methods, like buying calls or starting a covered call trade, which is a plus. When the stock price goes just a bit high, this makes a trade with a high reward-to-risk ratio.

Bear Put Spread

Another type of vertical spread is the bear put spread. You buy put options at a certain strike price and sell the same number of puts at a lower strike price at the same time. Both options have the same base asset and expire on the same date.

When a trader is negative about the underlying asset and thinks its price will go down, they use this approach. The strategy limits how much you can lose and how much you can make.

The price of stock has to go down for this plan to work. With a bear put spread, you can't go up in value as much, but you pay less in price. If outright puts are pricey, you can sell cheaper strike puts against them to make up for the high premium.

Covered Call

The most common way to use options, aside from simply buying call options, is through a covered call. A lot of people use this method because it makes money and lowers some of the risk of just holding the stock. In exchange, you need to be ready to sell your shares at a certain price. To use the strategy, you buy the underlying stock as normal and sell a call option on the same shares at the same time.

To give you an example, let's say you have a stock call option that covers 100 shares of stock. When you buy 100 shares of stock, you sell one call option against those shares at the same time. If the price of a stock goes up quickly, the long stock position covers the short call. This is why the strategy is called a "covered call."

Investors who only want to hold on to a stock for a short time and don't have a strong opinion about its future can use this strategy. They might want to make money by selling the call price or protect themselves in case the value of the underlying stock goes down.

Protective Collar

When you already own the underlying asset, you can buy an out-of-the-money (OTM) put option and write an OTM call option with the same end date. This is called a protective collar. Investors often employ this strategy after their long-term investment in a stock has yielded significant profits. By using a long put strategy, you can safeguard yourself from potential losses, as it locks in the potential sale price. On the other hand, you might have to sell your shares at a higher price, which means you miss out on the chance to make even more money.

Married Put

When you use a married put plan, you buy an asset and buy put options for the same number of shares at the same time. A person who owns a put option can sell stock at the strike price. One put option contract is worth 100 shares.

This is a way for investors to protect their potential risks when they hold stock. This is like an insurance policy; it sets a floor price for the stock price if it drops sharply. Because of this, it's also called a defensive put.

Let's say an investor buys 100 shares of stock and one put option at the same time. Investors like this plan because it protects them from losing money if the stock price goes down. While this is going on, buyers can make money with the prices going up. The only bad thing about this approach is that the investor loses the premium paid for the put option if the stock doesn't go down in value.

Iron Condor

When volatility is low, investors can profit from the iron condor, a neutral strategy. The investor has both a bull-put spread and a bear-call spread at the same time. For an iron condor, the investor sells one out-of-the-money put, buys one with a lower strike, sells one call, and buys one with a higher strike. This creates a bear call spread.

Each option has the same end date and covers the same topic. Spread width on the put and call sides is usually the same. This method makes a net premium on the structure and is meant to benefit from low volatility.

Long Straddle

When you use the long straddle options strategy, you buy both a call option and a put option on the same base asset at the same time. The strike price and expiration date for both options are the same. Investors often use this method when they believe the price of an underlying object will move significantly out of a certain range, but they are uncertain about its direction.

In theory, this gives you a chance to make as much money as you want. The biggest loss, on the other hand, is limited to the value of both option contracts.

Long Strangle

You buy an out-of-the-money (OTM) call option and an out-of-the-money (OTM) put option at the same time on the same base asset with the same expiration date in a long strangle options strategy. Each option has a different strike price. Investors who use this method think that the price of the base asset will change a lot, but they don't know which way it will move.

To effectively use this strategy, you could wager on news from a company's earnings report or an event associated with the Food and Drug Administration's approval of a pharmaceutical company's new treatment. During these times, you can expect price changes. The premium you paid for each choice is the most you can lose. Because the options bought are out of the-money, strangles are usually cheaper than crosses.

Iron Butterfly

In the iron butterfly strategy, you sell an ATM put and buy an OTM put. You buy an OTM call and sell an ATM call at the same time. Each option has the same end date and covers the same asset. This strategy is like a butterfly spread, but it uses both calls and puts instead of just one or the other.

This strategy is a mix of selling an ATM straddle and buying protection "wings." One can also view the building as having two spreads. Most of the time, both areas have the same width. There is no limit to how much the long OTM call can go up. The long OTM put protects against a decline (from the short put's strike price to zero).

The strike prices of the used options limit the potential profit or loss within a specific range. Investors like this plan because it makes them money, and there's a better chance of making a small profit with stocks that don't change much.

Long Call Butterfly Spread

For the previous strategies to work, they needed a mix of two different roles or contracts. When you use call options in a long butterfly spread, you use both a bull spread and a bear spread. Additionally, the spread will feature three distinct strike prices. The options all have the same asset and end date.

To make a long butterfly spread, buy one in-the-money (OTM) call option at a lower strike price, sell two at-the-money (ATM) call options, and then buy the third OTM call option. The wings of a healthy butterfly spread will all be the same width. We refer to this type of transaction as a "call fly," which results in a net loss. People buy a long butterfly call spread when they don't think the stock will change much before the end date.

If you don't think the price of the underlying stock will change much, this strategy works best. This is because the most profitable outcome is within the range of the strike prices for the options sold.

Pros and Cons of Trading Options

Conclusion

The options market can be scary for beginners, but there are many strategies to lower risk and increase return. Some strategies use more than one way to balance things out. Covered calls, collars, and married puts are some options available to those who already own the underlying asset. You can use straddles and strangles to take a position when the market is moving.