Options trading includes a range of techniques that use asset volatility, market trends, and risk metrics, such as options Greeks to formulate proper trading strategies. These methods enable investors to make well-informed choices, which are essential for carrying out options transactions. Therefore, anyone starting an options trading must understand these tactics.
Whether your level of expertise is high or low, becoming proficient with these strategies is essential. Imagine the potential of stock options, which can minimise risks and maximise your return on investment. Getting to understand these techniques will help you in several ways.
Types of Options Trading Strategies
Call and put options are two types of options, with call options granting the contract holder the right to purchase an underlying asset at the strike price before or on the expiration date, and put options granting the right but not the duty to sell the asset at the strike price. Call options are commonly used by investors when they believe the market is bullish, while put options are used when the market is negative.
Options trading techniques are classified into three groups based on market trends: bullish, bearish, and neutral. Bullish options are used when investors believe the underlying asset's price will rise, bearish options when it will fall, and neutral options when they are uncertain about the market trend. Apart from this, there are numerous strategies in options trading that you can check in the below table:
Bullish Options Strategies
When trading options, if investors believe the market is bullish, they employ the following bullish options trading tactics to maximise gains while minimising losses:
- Bull Call Spread
A Bull-Call spread is also one of the best option trading strategies for beginners. A Bull-Call Spread creates a range by combining two call options with differing strike prices. Both options use the same underlying asset and have the same expiration date. However, the investor and traders buy one At-The-Money call option while concurrently selling one Out-Of-The-Money call option.
A bull call spread is lucrative for the investor if the underlying asset's price, such as stocks, rises. The profit in this approach is restricted to the spread minus the net debit, but the loss is incurred if the stock price decreases.
- Bull Put Spread
A Bull-Put spread, like the Bull-Call spread, is a strategy in options trading. To generate a range, investors use two put options with different strike prices and the same expiration date. However, the investor and traders buy one out-of-the-money put option while concurrently selling one in-the-money put option. Investors earn again if the underlying asset's price, such as stocks, rises on or before the expiration date. This technique is designed to generate a net credit, or the net amount received while incurring a loss, if the underlying asset's price falls below the strike price of the long put option.
- Call Ratio Back Spread
This is a three-legged options strategy in which investors and traders purchase two out-of-the-money call options and sell one in-the-money call option. Profit potential is boundless. However, loss happens if the price of the underlying asset remains within a specified range.
- Synthetic Call
A synthetic call is one of the well-known option trading strategies for investors who have a positive long-term view of the underlying asset but have concerns about the negative risks. Purchasing put options on the same underlying asset, such as stocks acquired through direct investment after forming a favourable view, is part of the strategy. If stock prices rise, the profit potential is boundless, but the loss risk is limited to the size of the premium.
2. Bearish Options Strategies
The financial market is dynamic, with volatility resulting from a variety of external market conditions, which might cause the market to enter a negative trend. In such cases, options traders employ the following bearish options trading strategies:
- Bear Call Spread
This technique entails purchasing one Out-Of-Money call option with a higher strike price and simultaneously selling one In-Of-Money call option with a lower strike price, both with the same underlying asset and expiration date. The method is designed for a net credit, and investors earn if the price of the underlying asset declines.
- Bear Put Spread
Investors use the technique, similar to a bear call spread when they believe the underlying asset's price will decrease somewhat but not significantly. Using this method, investors buy one in-the-money put option while selling one out-of-the-money put option. The profit potential is restricted to the spread less the net debit, where the net debit is the difference between the premium paid and the premium received.
The Strip is a bearish to neutral three-legged strategy in which investors buy one call option, and two put options with the same underlying asset, strike price, and expiration date that are At-The-Money. Traders win from this approach if the underlying asset's price falls sufficiently before the expiration date.
- Synthetic Put
When investors believe that the market is in a negative trend and that the underlying asset may lose strength in the short future, they employ the synthetic put technique. The approach is also known as synthetic long put since investors profit from the underlying asset's price drop.
3. Neutral Options Strategies
Investors that have no notion where the underlying asset's price will go use neutral options methods. As a result, they employ the following neutral options trading strategies:
- Long and Short Straddles
The long straddle is a straightforward market-neutral strategy that consists of purchasing In-The-Money call and put options with the same underlying asset, strike price, and expiration date. Profit potential is infinite in this method, while loss potential is limited. The short straddle consists of selling call and put options with the same underlying asset, strike price, and expiration date.
- Long and Short Strangles
The options strangle strategy is similar to the straddle options strategy, but the purchase of out-of-the-money call distinguishes it and put options. Using the long strangle strategy, you buy one out-of-the-money call option and one out-of-the-money put option. Profit potential is limitless, whereas loss potential is restricted to the net premium. Selling one out-of-the-money put option and one out-of-the-money call option constitutes the short straddle. The greatest profit is the premium received, but the maximum loss is indefinite.
- Long and Short Butterfly
This technique combines bull and bear spreads with a set profit and risk, and the options are the same distance from the At-The-Money options. The long butterfly call spread consists of purchasing one In-The-Money call option, selling two At-The-Money call options, and then purchasing one Out-Of-The-Money call option. The short butterfly spread consists of selling one In-The-Money call option, purchasing two At-The-Money call options, and then selling one Out-Of-The-Money call option.
- Long and Short Iron Condor
This options strategy consists of one long and one short put option, as well as one long and one short call option with separate strike prices and the same expiry date. Unlike a bull put spread, the iron condor approach is a four-legged method that allows investors, innovators, and traders to gain from the market's low volatility. When the underlying asset's price is between the middle strike price at the time of expiry, the profit potential is greatest.
Advantages and Disadvantages of Option Trading
Here are the advantages and disadvantages of option trading:
|Advantages of Options Trading
|Disadvantages of Options Trading
|Higher Leverage: Options give more leveraging power, allowing investors to manage positions with a lesser investment via leveraging through brokers.
|Unlimited Losses: Option sellers suffer potentially infinite losses if the buyer exercises their right, whereas sellers are bound to purchase or sell at the agreed-upon price.
|Limited Downside: Option purchasers have the right, but not the responsibility, to exercise the contract. If the contract is not exercised, they can restrict their losses to the premium paid.
|Margin Requirements: Traders are required to have a minimum margin in their brokerage accounts. Failure to do so may result in margin calls or the liquidation of positions.
|Predetermined Price: Investors can set the stock price to a specific level, providing a hedge against direct investments and potentially minimising losses.
|Complexity: Options trading necessitates the study of complicated terminologies and methods, which may be time-consuming and difficult for traders to learn and execute flawlessly.
Diversified financial instruments, such as options, allow investors and traders to construct contracts with several asset classes, giving them flexibility and allowing them to choose not to exercise the contract if they are afraid of losing money. Options trading techniques may be utilised in every market state, from bullish to bearish, and if the market is unsure, neutral tactics can be used. A reliable Stock market app assists in executing these options strategies in varying market conditions for minimising losses and maximising profits. This enables the establishment of financial contracts with underlying assets, allowing purchasers to reduce their losses while increasing their profits.
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FAQs on Best Options Trading Strategies
A synthetic call is one of the most common and straightforward option strategies.
Because of their limitless loss potential, naked options such as covered calls and covered puts are the riskiest.
Synthetic calls are one of the least dangerous options strategies since they are simple and have a low loss potential.
No-loss option strategies don't exist; all strategies involve some level of risk. Hedging strategies like a protective put or collar can mitigate losses, but aren't entirely risk-free.
There's no entirely risk-free option strategy. Strategies like protective puts or collars aim to reduce risk, but don't eliminate it entirely.