Options Trading Strategies Explained
If you are looking to start trading assets of any kind — or even if you already have some experience — you may already know that it is not all just random. Attempting to trade by randomly buying and investing, and then equally randomly selling the assets is a sure way to lose all of your money very quickly.
Obviously, the same is true when it comes to trading options. It goes without saying that you need to know what you're doing, how options trading works, what's the point of it, and how you can make money. However, those are technical details.
Trading also involves a deeper level of awareness — a plan of what you are doing, what you wish to achieve, and methods used to actually achieving your goal. In other words, you need options trading strategies, and we have a few of them ready to share.
What are Option trading strategies?
As you can tell from the name, options trading strategies are basically plans that will help guide your actions and allow you to make a profit by trading options. These strategies have been proven to work time and time again, and are being used by experts around the world.
This is not a guarantee that they will work 100% of the time, but the chances are that they can be used for maximizing the returns while reducing the risks.
To clarify what these strategies are and what they look like, we have decided to list and explain some of the best and most popular of them right here. Hopefully, one or more of these will be able to help you reach your goals while trading options, and help you understand how it all works.
Most popular Option trading strategies
As mentioned, there are multiple option trading strategies that traders and investors tend to use. Strategies exist when it comes to trading and investing in any asset, and there are numerous ones for options trading. They come with a variety of rewards, but also with different risks.
1. Straddles & strangles
The first on the list is called Straddles and strangles. When it comes to straddles, you basically expect the asset to be very volatile. However, you also do not know in which direction its price might go. That's where the straddle strategy comes in, as it lets you buy a call and put at the same strike price, expiry date, and underlying price.
The strategy is very useful for those who expect something to happen to the stock, without knowing what the exact reaction might be. If the price has equal chances of going up or down, and you can't decide which one is more likely — this is likely one of the best strategies for you.
As for strangles, this is a strategy where an investor purchases an 'out of the money' call or put at the same time, once again for the same expiry date and the same asset. Just like last time, the investor who does this expects that the underlying asset's price will move up or down, without actually knowing which way it will be. This is considered to be a safe strategy as the only requirement is to have the asset's price move more than what the total premium you had to pay. It doesn't matter in which direction the price will go, as long as its movement is large enough.
2. Covered Call
A covered call is a pretty great option for those who have long asset investments, such as stocks. If you are neutral or slightly bullish, this strategy will work well for you.
Simply put, the strategy allows you to buy 100 shares of a stock and sell one call per 100 shares of said stock. In other words, this strategy lets you lower the risk of the stock investment itself, while at the same time, it lets you make a profit with the option.
3. Selling iron condors
In the third spot, we have a strategy that is called selling iron condors. For this strategy, the trade's position in non-directional, meaning that the asset can go up or down, similarly to what happens for the first strategy. While you will not care about which direction the price moves while using this strategy, it is important for it not to go grow or drop by a lot. To make it work, you need to sell a put and purchase an additional put, but at a lower strike price.
Then, purchase a call and sell a call at a higher strike price. The puts and calls are short. Now, with the stock price between the two calls or puts, you earn a profit. In other words, minor fluctuations in the price will make you money. But, if the price starts surging or sinking drastically, that will be a problem.
4. Married Put
Next, there is a strategy called married put, where an investor can purchase an asset — such as shares — and then simultaneously purchase put options for the same number of shares that they had purchased. In the end, the holder of the put option can sell their stock at the strike price.
This is a very useful strategy for those who are looking to protect their downside risk when they decide to become stockholders. In a way, this strategy is a type of insurance policy. If the price of the stock happens to experience a sharp fall, the strategy secures a certain price fall, which will protect the investor's money.
5. Protective Collar
Finally, there is a strategy called Protective Collar, which revolves around purchasing out-of-the-money put options and writing out-of-the-money call options at the same time, and for the same underlying asset.
This is one of the go-to strategies for investors who entered long positions in stock and have experienced major gains. Basically, by using this strategy, investors can achieve downside protection and have a trade-off that will potentially obligate them to sell shares at a higher price than the current stock level.
Basically, when investors use this strategy, they can be protected from losing money if the stock price falls. However, if surges, the investor has to sell their long stock at the short call strike. However, this is beneficial to the investor, as they will see gains from the sale.
With that, we would end our list of some of the most popular and best-known options trading strategies out there. Trading options can be very rewarding if you know what you are doing, and since the market can be quite unpredictable, using some of the tested strategies and investment plans can save your investment, at worst, and allow you to make decent gains, at best.
Author: Ali Raza - A journalist, with experience in web journalism and marketing. Ali holds a master's degree in finance and writes extensively about the financial markets and fin-tech industries.