Options trading can be a valuable tool for investors and traders. Numerous options trading strategies can help traders profit and limit risk.
A trader can buy calls on a stock when they believe a stock price will rise within a specified time frame. Buying calls is a good strategy when a trader doesn’t want to buy the stock outright but still wants to profit from the price increase.
Traders buy puts on a stock when they believe a particular stock will fall in price in a specified time frame. They can make money even though the stock falls. Another reason for long puts is to hedge losses on stocks they do own in their portfolio. Even though they lose money on the stock price falling, they profit on the long puts.
A trader sells call options on stocks they already own when they expect a stock price to remain relatively unchanged or fall in price before the option expiration date. They are called covered because the trader owns the underlying stock of the calls they are selling. If the stock remains flat or unchanged, the trader will profit from the premium they receive when selling the calls.
A naked call is like a covered call, except in this case, the trader does not own the underlying stock for the options he is selling. If the trader that bought the calls exercises the options, the seller will have to go to the market, buy the stock and deliver it. These are riskier than covered calls.
Short puts are when a trader sells puts. Like selling calls, the seller of the puts will profit from the premium if the put options expire worthless. If the trader that bought the options decides to exercise their right to the stocks, the seller would have to buy those shares at the strike price.
Straddles and Strangles
Straddles allow traders to profit regardless of whether the underlying market index or stock goes up or down in price. A long straddle is when a trader buys a call option and a put option and works best during high volatility. A short straddle involves selling a call and a put at the same time and works best when prices are not expected to move much.
This strategy can provide both profit and the ability to buy the stock at a price lower than they might have with a market buy order. According to the professionals at SoFi Invest, “Here’s how it works: an investor writes a put option for Miner CC they do not own with a strike price lower than shares are currently trading at. The investor needs to have enough cash in their account to cover the cost of buying 100 shares per contract written, in case the stock trades below the strike price upon expiration (in which case they would be obligated to buy).”
Bull Put Spreads
Bull put spreads are one of the more complicated options trading strategies combining a long put with a lower strike price and a short put with a higher strike price. This strategy can limit losses and also create a profit with time decay.
This strategy uses a combination of a bear spread and a bull spread and can use either calls or puts. It involves four different options. Butterfly spreads are used when the underlying index or stock is expected to stay mostly flat through the life of the option.
The iron condor consists of two calls and two puts (four option legs). Iron condors are used by traders to earn small but consistent profits when a stock has little volatility.
The last three options trading strategies are excellent to control risks and earn consistent income. Each of these strategies has a place in options trading.