There are some advantages to trading options.
Bearish Option Strategies
The following are basic option strategies for beginners. This is the preferred strategy for traders who:. Options are leveraged instruments, i. A standard option contract on a stock controls shares of the underlying security. Because the option contract controls shares, the trader is effectively making a deal on shares. Potential profit is unlimited, as the option payoff will increase along with the underlying asset price until expiration, and there is theoretically no limit to how high it can go. A put option works the exact opposite way a call option does, with the put option gaining value as the price of the underlying decreases.
While short-selling also allows a trader to profit from falling prices, the risk with a short position is unlimited, as there is theoretically no limit on how high a price can rise. With a put option, if the underlying rises past the option's strike price, the option will simply expire worthlessly. The maximum profit from the position is capped since the underlying price cannot drop below zero, but as with a long call option, the put option leverages the trader's return.
This is the preferred position for traders who:. A covered call strategy involves buying shares of the underlying asset and selling a call option against those shares. When the trader sells the call, he or she collects the option's premium, thus lowering the cost basis on the shares and providing some downside protection. In return, by selling the option, the trader is agreeing to sell shares of the underlying at the option's strike price, thereby capping the trader's upside potential. In exchange for this risk, a covered call strategy provides limited downside protection in the form of premium received when selling the call option.
A protective put is a long put, like the strategy we discussed above; however, the goal, as the name implies, is downside protection versus attempting to profit from a downside move. If a trader owns shares that he or she is bullish on in the long run but wants to protect against a decline in the short run, they may purchase a protective put. If the price of the underlying increases and is above the put's strike price at maturity , the option expires worthless and the trader loses the premium but still has the benefit of the increased underlying price. Hence, the position can effectively be thought of as an insurance strategy.
The trader can set the strike price below the current price to reduce premium payment at the expense of decreasing downside protection. This can be thought of as deductible insurance. The following put options are available:. The table shows that the cost of protection increases with the level thereof.
If, however, the price of the underlying drops, the loss in capital will be offset by an increase in the option's price and is limited to the difference between the initial stock price and strike price plus the premium paid for the option. These strategies may be a little more complex than simply buying calls or puts, but they are designed to help you better manage the risk of options trading:.
Options offer alternative strategies for investors to profit from trading underlying securities. There's a variety of strategies involving different combinations of options, underlying assets, and other derivatives. Options are very versatile investment tools, and although most beginners feel that the only thing they want to accomplish is to "make money" there are other considerations. The primary goal for options traders is almost always making money.
However, more experienced traders learn to appreciate that options can be used to obtain other desirable characteristics for their investment portfolios. For example, options can be used to:. A word of caution is in order. Rookies must understand one firm principle when trading: Never place money at risk unless you are certain that you understand exactly what you are doing.
There is nothing inherently wrong with paying for advice, but you must do your part and be certain that the trade is suitable for your risk tolerance see 5. Plus, if you do not understand what has to happen for the position to make money and how it can lose money , then there is no reason to make the trade. If you begin trading any options strategy without a firm understanding of how each of these strategies works and what you are trying to accomplish when using them, then it becomes impossible to manage the trade efficiently.
In other words, when trading options you cannot adopt a buy and hold philosophy. Options are designed to be traded, not necessarily actively, but when you make a trade, there is always an opportune time to exit. Hopefully with a profit, but a good risk manager that's you knows when a specific trade is not working and that it is necessary to get out of the position. If you must take a loss, so be it. Never hold a losing trade hoping that it will get back to break even. The following short list of strategies contains the methods that I recommend.
For more sophisticated traders:. These are six strategies recommended for options traders.
Best options trading strategies and tips
There are other good strategies available, but these methods are that each is easy to understand. When getting started with options, it is advantageous to work with strategies that allow you to be confident that you know how to open, manage, and close your positions. A short put options trading strategy can help in generating regular income in a rising or sideways market but it does carry significant risk and it is not suitable for beginner traders. A Bull Put Spread involves one short put with higher strike price and one long put with lower strike price of the same expiration date.
A Bull Put Spread is initiated with flat to positive view in the underlying assets. Bull Put Spread Option strategy is used when the option trader believes that the underlying assets will rise moderately or hold steady in the near term. It consists of two put options — short and long put.
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Strike price can be customized as per the convenience of the trader. If Mr. A believes that price will rise above or hold steady on or before the expiry, so he enters Bull Put Spread by selling Put strike price at Rs. The net premium received to initiate this trade is Rs. Maximum profit from the above example would be Rs. It would only occur when the underlying assets expires at or above In this case, both long and short put options expire worthless and you can keep the net upfront credit received that is Rs. Maximum loss would also be limited if it breaches breakeven point on downside.
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However, loss would be limited to Rs. For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry. Delta: Delta estimates how much the option price will change as the stock price changes. The net Delta of Bull Put Spread would be positive, which indicates any downside movement would result in loss. Vega: Bull Put Spread has a negative Vega. Therefore, one should initiate this strategy when the volatility is high and is expected to fall.
Gamma: This strategy will have a short Gamma position, so any downside movement in the underline asset will have a negative impact on the strategy. A Bull Put Spread Options strategy is limited-risk, limited-reward strategy. This strategy is best to use when an investor has neutral to Bullish view on the underlying assets. The key benefit of this strategy is the probability of making money is higher as compared to Bull Call Spread. A Long Call Ladder is the extension of bull call spread; the only difference is of an additional higher strike sold.
The purpose of selling the additional strike is to reduce the cost. It is limited profit and unlimited risk strategy. It is implemented when the investor is expecting upside movement in the underlying assets till the higher strike sold.
Learning Center - Options Strategies
The motive behind initiating this strategy is to rightly predict the stock price till expiration and gain from time value. A Long Call Ladder spread should be initiated when you are moderately bullish on the underlying assets and if it expires in the range of strike price sold then you can earn from time value factor. Also another instance is when the implied volatility of the underlying assets increases unexpectedly and you expect volatility to come down then you can apply Long Call Ladder strategy.
Strike price can be customized as per the convenience of the trader i.
Suppose Nifty is trading at An investor Mr. A thinks that Nifty will expire in the range of and strikes, so he enters a Long Call Ladder by buying call strike price at Rs. The net premium paid to initiate this trade is Rs. It would only occur when the underlying assets expires in the range of strikes sold. Maximum loss would be unlimited if it breaks higher breakeven point. However, loss would be limited up to Rs. Delta: At the time of initiating this strategy, we will have a short Delta position, which indicates any significant upside movement, will lead to unlimited loss. Vega: Long Call Ladder has a negative Vega.
Therefore, one should buy Long Call Ladder spread when the volatility is high and expects it to decline.
Theta: A Long Call Ladder will benefit from Theta if it moves steadily and expires in the range of strikes sold. Gamma: This strategy will have a short Gamma position, which indicates any significant upside movement, will lead to unlimited loss. A Long Call Ladder is exposed to unlimited risk; it is advisable not to carry overnight positions.
Also, one should always strictly adhere to Stop Loss in order to restrict losses. A Long Call Ladder spread is best to use when you are confident that an underlying security will not move significantly and will stays in a range of strike price sold. Another scenario wherein this strategy can give profit is when there is a decrease in implied volatility. A covered call options trading strategy is an Income generating strategy which can be initiated by simultaneously purchasing a stock and selling a call option.
It can also be used by someone who is holding a stock and wants to earn income from that investment. Generally, the call option which is sold will be out-the-money and it will not get exercised unless the stock price increases above the strike price.