Once you understand the basics of how options work, the next stage is to understand each key options trading strategy. That will be the focus of our attention in this article. If you haven’t read the ‘Options for Beginners‘ article, please go back and red that one first. Every options strategy will address both “calls” and “puts” or both simultaneously.
Where an options trading strategy concentrates on just one of these elements, they are called “one-legged.” One-legged strategies are simpler to understand, but they are still not risk-free.
The Long Call Options Trading Strategy
What is the long call?
In this options trading strategy, an investor has a belief that the stock will rise in value. A long call means that the investor has the right to buy the stock at the strike price in the future. The strike price will be around the current price.
The long call explained
Say, for example, the current price of a stock is $100 a share and you buy a long call because you think the price will rise. The cost of the premium is $3 a share. It turns out you are right, and the shares are worth $150. So you use your option to buy at $100 and then sell them straightaway at $150 and make a tidy profit of $47 a share.
The Long Put Options Trading Strategy
What is the Long Put?
Buying a long put is done because it is expected that the stock will go down in value. The word “long” does not refer to the length of time before expiration. It refers to the trader’s plan to sell it at a higher price later on. In this options trading strategy, the more the stock goes down in value, the more profit the trader is likely to make.
The Long Put Explained as a Trading Strategy
An example, the current price of a stock is $100 a share and you buy a long call because you think the price will rise. The cost of the premium is $3 a share. It turns out you are right, and the shares are now only worth $50. So, you use your option to buy at $50 and then sell them straightaway at $100 and make a cool profit of $47 a share.
The Married Put Options Trading Strategy
What is a Married Put?
A married put is where an investor who holds a long position in stock buys a put option for the same price on the same stock in order to protect themselves against a reduction in the stock’s value. It is very similar to a covered call (see below).
The Married Put Explained as a Trading Strategy
The plus side of this type of strategy is that in the worst scenario, the investor can make a small loss but still make some gains from any increase in price. Plus, the put side is a protective hedge if you own the underlying security. The put gives you an option to sell the stock at a certain price no matter where the market is trading. The downside is that the premium for the put option is likely to be substantial.
The Covered Call Options Trading Strategy
What is a covered call?
In a covered call, the investor selling owns the same amount of the individual security. The investor has a long position in stock The investor then sells some call options for the same stock to create an income.
The investor’s “long position” is the cover, simply because the investor is in a position to hand over the shares if the buyer of the call option chooses to take up their option.
The covered call explained
The investor is only expecting a small increase or decrease in the value of the stock. This method allows them to generate an income from premiums during the lull in the movement of that stock. The maximum profit will be restricted to the set strike price of the short call, minus the purchase price of the actual stock, plus any premium s obtained. On the other hand, the maximum loss is the same as the purchase price of the actual stock minus the premium received.
What is a long position?
This is where the investor has purchased stock, or has a buy option on the asset, with the expectation that the stock will increase in value.
What is a short position?
A short position occurs when a trader sells a security while planning to repurchase it or covering it later at a lower price. The trader would do this if they believed the price of the stock was going to go down in the near future. If the trader sells the stock without actually having it, this is called a naked short (and illegal in the USA).
There are many options trading strategies that are out there in the market. The focus on this article was to a better understanding of some basic strategies. If you haven’t had a chance to read my options for beginners post, please make sure you go back and read that one as well if anything in here seemed too advanced. Personally, I like trading options for income with some advanced strategies known as spreads. I can go into more detail on those in another article, but typically I like trading options from ETFs. Many ETFs have weekly options that you can buy and sell for only a week. It limits the time risk of your position and can even work as an investment hedge.
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