10 Options Strategies to Know

10 Options Strategies to Know

10 Options Strategies to Know:- Traders frequently enter the options market with minimal knowledge of the various options methods at their disposal. Numerous options methods aim to minimise risk while optimising reward. Traders may become proficient in leveraging the power and flexibility that stock options offer with a little work. These ten options methods are essential knowledge for any investor.

Covered Call

Buying a naked call option is one way to use calls. A straightforward covered call or buy-write can also be structured. Because it lowers some of the risk associated with being long on the stock alone and produces income, this strategy is quite popular. The short strike price is the specified price at which you must be prepared to sell your shares in exchange for the trade-off. In order to put the technique into action, you buy the underlying stock as usual and at the same time write down—or sell—a call option on those identical shares.

Let’s take an example where an investor uses a call option on a stock where each call option represents 100 shares of the stock. An investor would simultaneously sell one call option against every 100 shares of stock they purchased. Because the investor’s short call is protected by the long stock position in the case of a sharp increase in the stock price, this technique is known as a covered call.

When an investor has a short-term holding in the stock and is unsure of its future trajectory, they may decide to employ this technique. They may be trying to hedge against a possible drop in the value of the underlying stock or make money from the selling of the call premium.

See how the long share position balances out the negative P&L from the call as the stock price rises in the profit and loss (P&L) graph above. The investor may effectively sell their shares at a higher level than the strike price (the strike price plus the premium earned) since they receive a premium for selling the call when the stock passes through the strike price to the upside. The P&L graph of the covered call resembles that of a brief, naked put in many ways.

Married Put

When using a married put strategy, an investor buys stock or another asset and puts options on an equal number of shares at the same time. 2. A put option is worth 100 shares, and the holder has the option to sell the stock at the strike price.

When owning stocks, an investor may decide to employ this technique to reduce their negative risk. This approach creates a price floor in the event that the stock price drops significantly, much like an insurance policy. For this reason, it sometimes goes by the name “protective put.”

Assume, for illustration purposes, that a shareholder purchases 100 shares of stock and one put option at the same time. Because they are shielded from the downside in the event that the stock price changes negatively, this investor may find this method intriguing. If the stock’s value increased, the investor would also be able to take advantage of any chance for profit. The investor loses the put option premium if the stock does not decrease in value, which is the single drawback to this approach.

The long stock position is shown by the dashed line in the P&L graph above. You can see that the losses are constrained when the stock price drops when you combine the long put and long stock bets. Above the put premium paid, the stock can, however, benefit from the upside. The P&L graph of a married put looks like the P&L graph of a long call.

Bull Call Spread

An investor uses a bull call spread strategy when they buy calls at a certain strike price and sell the same quantity of calls at a higher strike price. The identical underlying asset and expiration date will apply to both call options.

An investor who is optimistic on the underlying asset and anticipates a modest increase in price generally employs this kind of vertical spread approach. By employing this tactic, the investor can lower the net premium paid and restrict the trade’s potential gain (in contrast to purchasing a naked call option outright).

You can see that this is a bullish approach from the P&L graph above. The trader must see an increase in stock price in order to profit from the transaction in order for this technique to be correctly implemented. A bull call spread comes with the trade-off that your upside is constrained (despite the fact that the premium amount is lowered). Selling higher strike calls versus outright calls is one strategy to counteract the increased premium associated with them. This is the construction of a bull call spread.

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Bear Put Spread

Another vertical spread method is the bear put spread. Using this method, the investor buys the same quantity of put options at one strike price and concurrently sells them at a lower strike price. Both options have the same expiration date and are bought for the same underlying asset. When a trader is pessimistic about the underlying asset and believes its price will drop, they employ this tactic. Both modest gains and small losses are possible with this method.

This is a bearish strategy, as you can see in the P&L graph above. The stock price must decline in order for this method to be implemented effectively. Your upside is constrained but your premium spend is decreased when you use a bear put spread. One strategy to counteract the large premium associated with outright options would be to sell lower strike puts against them. This is the building block of a bear put spread.

Protective Collar

Buying an out-of-the-money (OTM) put option and concurrently writing an OTM call option (of the same expiration) when you already own the underlying asset is known as the protective collar technique. Investors commonly employ this tactic following significant profits made by a long position in a stock. Because the long put helps lock in the possible sale price, this gives investors protection against downside volatility. The drawback is that they could have to give up the chance to make more money by having to sell their shares at a higher price.

An illustration of this tactic would be if a shareholder had 100 IBM shares at $100 on January 1st. By selling one IBM March 105 call and concurrently purchasing one IBM March 95 put, the investor might create a protective collar. Below $95, the trader is safeguarded till the expiration date. The trade-off is that if IBM trades at that price before expiration, they could have to sell their shares at that price.

You can see that the protective collar is a combination of a long put and a covered call in the P&L graph above. Since this trade setup is neutral, the investor is safeguarded in the event that the stock declines. Potentially having to sell the long stock at the short call strike is the trade-off. But since they have already made money on the underlying shares, the investor will probably be pleased to do this.

Long Straddle

When an investor buys a call and a put option on the same underlying asset at the same strike price and expiration date, they are engaging in a long straddle options strategy. This approach is frequently used by investors who predict a large change in the price of the underlying asset outside of a given range, but they are not sure which way the move will go.

In theory, this approach gives the investor the chance to make limitless profits. In addition, the total cost of the two option contracts is the maximum loss this investor may incur.

Long Strangle

Using a long strangle options strategy, an investor buys an out-of-the-money call option and an out-of-the-money put option simultaneously on the same underlying asset with the same expiry date, each with a different strike price. Guy Cohen’s “The bible of options strategies: the definitive guide for practical trading strategies.” 2005; Pearson Education. Investors that employ this technique think there will be a significant fluctuation in the price of the underlying asset, but they don’t know which way it will go.

This tactic, for instance, may involve speculating on information from a company’s earnings release or an occasion involving the Food and Drug Administration’s (FDA) approval of a pharmaceutical stock. Losses are capped to the price of the premiums paid for each of the two choices. Because they are out-of-the-money options, straddles will nearly always cost more than straddles.

Long Call Butterfly Spread

The prior approaches have necessitated combining two distinct roles or agreements. An investor will combine both a bull spread strategy and a bear spread strategy in a long butterfly spread utilising call options. Additionally, they’ll employ three distinct strike pricing. Every option has the same expiration date and underlying asset.

By buying one in-the-money call option at a lower strike price, selling two at-the-money (ATM) call options, and acquiring one out-of-the-money call option, one may create a long butterfly spread. There will be equal wing widths in a balanced butterfly spread. A net debit is the outcome of what is referred to as a “call fly” in this case. When an investor believes that the stock will not move significantly before expiration, they would buy a long butterfly call spread.

Iron Condor

An investor who uses the iron condor method holds both a bear call spread and a bull put spread at the same time. Selling one OTM put and purchasing one OTM put with a lower strike (a bull put spread) and buying one OTM call and selling one OTM call with a higher strike (a bear call spread) are the steps involved in constructing an iron condor.

Every option is based on the same underlying asset and has the same expiration date. The spread widths of the put and call sides are usually equal. This trading method is intended to profit from a stock that is exhibiting minimal volatility and generates a net premium on the structure. Due of the strategy’s seeming high chance of producing a little premium, many traders employ it.

Iron Butterfly

An investor will purchase an out-of-the-money put and sell an at-the-money put in the iron butterfly approach. They will also purchase an out-of-the-money call and sell an at-the-money call concurrently. Every option is based on the same underlying asset and has the same expiration date. This technique is similar to a butterfly spread, except instead of using only calls or puts, it utilises both.

This is essentially a combination of buying defensive “wings” and selling an at-the-money straddle. The structure might alternatively be seen as two spreads. It is typical for both spreads to have the same width. Long, out-of-the-money calls offer protection against potential upside that never ends. The downside is guarded against by the long, out-of-the-money put (from the short put strike to zero). Depending on the strike prices of the options employed, both profit and loss are constrained to fall within a particular range. Because of the income it produces and the increased likelihood of a minor gain with a non-volatile company, investors choose this method.

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