Top 10 Options Trading Strategies
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What is options trading? Is it really worth learning? How does it differ from other forms of investing? What should I look out for before choosing an option strategy?
It has been brought to my attention that information in this post is currently incorrect. I will be updating this post shortly
This post is originally from portfolio-hub.co.uk
Options trading is a form of derivatives where investors speculate on the price movement of a certain asset or index over a specified time period. This type of investment has become very popular due to its high returns and low risk compared to other types of investments.
There are several ways to trade options, such as long call, short put, covered calls, straddles, etc. The key to successful options trading lies in knowing the difference between these strategies and finding which one works for you.
1. Long Straddle
A long straddle is one of the most popular strategies among traders because of its simplicity and ease of implementation. In fact, some people refer to it as the “straddling donkey.”
The basic concept behind a long straddle is that you are willing to take both sides of a trade. For example, let’s say you want to buy shares of IBM stock. You might decide to sell short shares of Microsoft stock, too. If the price of IBM rises, you’ll make money; if the price of Microsoft falls, you’ll lose money.
In general, a long straddle involves taking a position on both the upside and downside of a security. To do this, you must determine how many contracts you want to hold. Let’s assume you’re interested in holding 10 contracts.
You’d place a limit order to buy 10 contracts of IBM at $100 per contract. If the price closes above $100, you’d receive 10 contracts for free. However, if the price closed below $100, you’d lose 10 contracts.
This strategy requires careful risk management. If the market moves against you, you could end up losing money. Conversely, if the market moves in your favour, you could make a lot of money.
To minimize losses, you can use stop loss orders to protect yourself from large swings in the market. Stop loss orders allow you to set a price level where you’ll automatically exit a trade if the price reaches that level.
For example, if you’re buying IBM, you might set a stop loss order at $90. If the price drops below $90, you’ll close out the trade.
If you’re selling Microsoft, you might set a maximum profit target at $80. If the price exceeds $80, you’ll keep the trade open; however, if the price goes below $80, you’ll close the trade.
2. Protective Collar
A protective collar is a type of stop loss trading strategy that allows you to lock in profits while protecting against losses. This strategy is typically done after a large gain. While it sounds like a great idea, there are some risks involved.
Protective collars work by locking in profits at a certain price level. If the stock drops, the protective collar stops selling shares. When the stock rises again, the protective collar buys shares back at the same price.
The problem with protective collars is that they don’t always protect against losses. If the stock falls too far, the protective collar won’t sell shares fast enough to catch up. In addition, protective collars aren’t designed to protect against big losses. Instead, they’re meant to limit small gains and prevent further losses.
3. Bull Call Spread
Bull call spreads are typically used in situations where investors are bullish on the market. They combine a vertical spread and a put option strategy. A bull call spread consists of selling one low-strike call and buying another high-strike call. This creates a synthetic long position while reducing the cost of the trade compared to buying both options separately.
4. Married Put
A married put allows the investor buy both the stock and put option. This strategy is useful if you think the stock is oversold and could go up further. You are buying the stock and selling the put option. If the price goes down, you lose nothing because the put option expires worthless. However, if it rises, you make money because the put option becomes worth something.
The premium paid for the put option will depend on how much upside potential there is for the stock. For example, if the stock is trading close to its 52 week high, the premium will be lower because it is less likely that the stock will rise further. Conversely, if the stock is very cheap, the premium will be higher because it is more likely that the stock will continue rising.
5. Iron Condor
An iron condor is a relatively simple strategy, but it requires discipline and patience. If you execute it properly, you can make money over long periods of time. This strategy is typically traded against SPY or QUALCOMM.
There is a lot of volatility associated with iron condors, especially when markets are stressed. During those times, there is often a huge amount of selling pressure on the short side. When that happens, investors tend to sell out of stocks like SPY and QQQ. As a result, there is a large supply of shares available for purchase. This creates opportunities for traders looking to buy low and sell high.
The iron condor strategy works best when the underlying stock price is moving up and down. In other words, when the market is volatile.
6. Long Strangle
A long strangle is usually less expensive than striding the same position on the exact same stock. This strategy is similar to covered calls except you pay both premium and interest cost. A long strangle is similar to buying two options on the same stock. You buy one call option and sell another put option on the same stock. The difference is that you pay the premium on the call and the seller pays the premium and interest on the put.
7. Long Call Butterfly Spread
A butterfly spread combines two strategies — long calls and short puts — into one. In a bull spread, the investor buys both the call and put options. If the stock rises, he collects his premium; if it falls, he loses nothing. But in a bear spread, the investor sells both the call and put. He makes money if the stock goes up, but he pays out if it drops.
The strike price determines how much money the investor wants to spend. If the market moves down, the investor could lose money, depending on how far the stock declines. However, if the stock rises, the investor wins big.
8. Bear Put Spread
A bear put spread is a type of option strategy where you buy puts and sell calls. This strategy is used to profit off a decline in stock prices. If you believe the price of a stock will drop, you might want to consider buying puts and selling calls. You do this because you think the price of the shares will fall. When the price falls, the puts expire worthless and you make money.
The key to making money with a bear put spread is finding the right strike price. Strike prices represent the price at which you will receive the underlying asset.
Bear put spreads work best when there is a lot of volatility in the market. They can help you avoid big losses if the market declines. However, you must watch out for large gains. If the market rises too high, you could lose money.
9. Covered Call
A covered call is a strategy in which an investor buys shares and simultaneously sells a call option against them. This allows the investor to profit from both rising prices and falling prices.
The downside is that it requires the investor to buy shares at a lower price than he might otherwise pay. If the share price rises above the call option’s strike price, the investor loses money. On the other hand, if the share price falls below the strike price, the investor makes money.
In addition, there are some risks associated with covering calls. For example, if the market moves quickly, the options contract could expire worthless. Also, the investor must decide whether to sell the shares immediately or wait until expiration.
10. Iron Butterfly
Iron butterflies are popular among investors looking to hedge against stock market fluctuations. They work like a spread, but use both puts and calls. There are several variations of the strategy, including the inverted iron, which is very similar a covered call writing strategy called a straddle.
Mistakes Beginner Option Traders Make
The mistakes made by novice traders are often easy to spot because they are obvious. However, there are some less obvious mistakes that beginners make. These include making trades without having an exit strategy, trading illiquid options, waiting too long to buy back shorts, ignoring index options, legging into spreads, and failing to factor in upcoming events.
Where can I practice options trading?
Paper trading allows you to test strategies without risking real money, while practicing against demo accounts. This gives you a chance to hone your strategy and see how it performs without having to risk actual capital.
Trading platforms offer paper trading tools, allowing you to trade options for no cost. There are many different types of trading platforms; some charge fees, others do not. Some platforms require you to deposit funds into an account before you can start trading. Others don’t.
Some of these platforms include:
OptionHouse — free platform with no minimum deposit required
TradeStation — one of the most popular platforms available, with a wide range of features
OptionsXpress — another free platform
Summary
There are many ways to trade options. You should choose the method that works best for you. Once you have chosen your strategy, you need to learn about the various types of options and their characteristics. Then, you need to find a broker who offers the type of options you want to trade. Finally, you need to learn how to execute your strategy using paper trading.
As a head up, options trading is not my go to investing strategy. I personally invest long term into the stock market. However, if you want to learn more about options trading then check out this book on Amazon (affiliate link) where you can learn more about the best beginner strategies
I hope you found this blog post helpful, if you did then consider leaving some feedback in the comment section down below.
Thanks for reading 😀
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FAQ
Which Options Strategies Can Make Money in a Sideways Market?
A sideways market is one where stock prices don’t change much over time, making it a low-volatility environment. Short straddles, short strangles, and long butterflies all profit in such cases, where the premiums received from writing the options will be maximized if the options expire worthless (e.g., at the strike price of the straddle).
Source: investopedia.com
Where Do Options Trade?
Listed options trade on specialized exchanges such as the Chicago Board Options Exchange (CBOE), the Boston Options Exchange (BOX), or the International Securities Exchange (ISE), among others. These exchanges are largely electronic nowadays, and orders you send through your broker will be routed to one of these exchanges for best execution.
Source: investopedia.com
What is a call option?
In its most basic form, a call option is used by investors who seek to place a bet that a stock will go up in price. Buying a call option contract gives the owner the right (but not the obligation) to purchase shares at a pre-specified price for a predetermined length of time. As the stock price goes up, so does the value of each option contract the investor owns. Conversely, if the stock price goes down, so does the value of the call option. Each contract represents 100 shares of stock.
Source: stockbrokers.com
Is options trading risky?
Yes. Options trading is a form of leveraged investing and thus is inherently risky. Any time an investor is using leverage to trade, they are taking on additional risk. Many times, this risk is unforeseen and not easily quantified.
Source: stockbrokers.com
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