Having knowledge of trading strategies is a plus if you are eyeing hopping into options trading. Although these options trading strategies are a bit complicated but they will help you cut off the risk while maximizing profits on your investments.
This blog is dedicated to helping you understand the basic option trading strategies to maximize returns on your investment, but before getting into the tricky strategies, let's understand what options actually are and how do they work.
What Are Options?
Options are financial instruments that are based on the value of a financial asset such as stocks. Depending on the type of contract, the holder of an option can buy or sell an asset. Options trading is mainly made online or through the retail brokers
One of the basic terms you will encounter while trading options is the ‘Strike Price’. The strike price is the price stated for each options contract. Each of these contracts will be bound by expiry date and this will be the date till when the investor has to exercise his opinion.
You will also encounter terms like ‘Call Option” and “Put Option” while investing in this market.
The term call options refer to the right of an option holder that enables him to buy a specific asset at a predetermined price within a predetermined time frame. On the flip side, Put Options are the option holder’s right that enables him to sell an asset at a predetermined price and time frame.
While options trading, make sure that options give you the due right to buy or sell an asset but you don’t have the obligation.
Although investors can earn huge profits while trading options, it is necessary to weigh the risk attached to each contract.
Beginners must have this basic understanding that, while buying or selling an option, the option holder is selling the contract but not the asset.
Basic Options Trading Strategies
Following basic strategies can help the investors increase returns on their investment and can also help them hedge their current position.
Number One: Count On The Covered Calls
The first strategy that option holders can consider is, they can simply make naked calls or can consider the buy-write option or the covered calls. This is one of the best strategies popular among options traders.
What’s the benefit of this strategy is, it helps the traders generate more income while reducing the risk factor.
To execute this strategy, what you have to do is, purchase the stocks like you normally do and write, sell or count on the call option for those particular shares.
Number Two: Married Put Is Another Popular Strategy
Following the Married Put strategy, the investors buy assets and at the same time, they purchase put options for an equal number of shares. Now, the put option holder has the due right to sell the stock on its strike price, and every contract is worth 100 shares.
This strategy is used when an investor wants to protect his downside risk while holding a stock. It functions like an insurance policy for the investors and develops a price floor at times when the stock prices fall sharply.
Number Three: The Protective Collar Strategy
The protective collar strategy works when an investor purchases an out-of-the-money Put option and writing an OTM call option at the same time.
This strategy is followed when investors experience substantial gains in a stock. It also enables the investors to have downside protection.
Number Four: The Bull Call Spread Strategy
The Bull Call Spread Strategy refers to a strategy where an investor buys call at a predetermined strike price while selling the equivalent number of calls at the same on an increased strike rate. For both the call options, the investor will have to cope with the same expiry date.
This strategy can work wonders if the investor is bullish and is expecting a slight increase in the value of assets. This strategy also is helpful in limiting the upside and the entire premium spent.
Number Five: The Long Strangle Strategy
Following this strategy, the investors purchase a call option (out-of-the-money call option) and a put option (out-of-the-money put option) simultaneously on different strike prices. While the expiration for both the put option and call option remains the same on the same underlying asset.
This strategy is applied when an investor is sure about the movement of asset price but has no idea in which direction will the asset price movement.
You may also want to read: Understanding Annuities: Here Is How Annuities Work In 2022
The Last Words
Although the above-mentioned strategies would sound difficult to you, they can easily be understood by grasping the basic options concepts.
When put correctly, these options trading strategies can work wonders for you, and upon failing to apply them correctly, you might have to bear huge losses.
