Options trading is where savvy investors navigate the financial markets with finesse. In this article, we will delve into five indispensable options trading strategies that can elevate your investment game.
Whether you’re a seasoned trader or just dipping your toes into the options pool, these strategies are designed to empower you with the knowledge needed to make informed decisions and maximize your returns.
Call and Put Options Explained
You’ve likely encountered the terms “Call” and “Put” options. Understanding these financial instruments is crucial for any savvy investor. Let’s delve into the nuances of Call and Put options to empower your financial decisions.
- Call option: The holder of a call option has the right to buy an underlying asset at the exercise price, or strike price, before or at the expiration date of the options contract. Usually, you buy a call option if you anticipate the underlying asset’s price rising above the exercise price. You can then buy the underlying asset for the exercise price and make a profit.
- Put option: A put option grants the holder the freedom to sell the underlying asset at the exercise price before or at contract expiration. You’d generally buy a put option if you expect the underlying asset’s price to fall below the exercise price. If it does, you can exercise the put option for a profit.
The world of options trading is complex and carries a high level of risk. Instead of navigating it alone, contact expert options trading brokers to ensure you get the most out of your trades.
In the meantime, read on to learn more about five strategies to utilize.
1. Long Call
The long call is the most basic call option strategy. You “go long” by wagering that the underlying stock’s price will rise above the exercise price by the date the options contract expires.
Long call example
- You identify a call option with an exercise price of $55, which expires in three months.
- The premium (the agreed price you’ll pay to the seller of the option) is $3 per share. You buy the call option, which usually covers 100 shares. So, the total premium is $300.
- At expiration, the price of the shares rises to $60. You exercise your call option and buy 100 shares at the exercise price of $55 each.
- The profit you’d make is the difference between the market price of the stock ($60-$55), which is $5, multiplied by 100 (the number of shares), amounting to $500, minus the premium ($300). This leaves you with a profit of $200.
2. Covered Call
You perform a covered call when you sell a call option and buy the underlying stock for the option. This means buying 100 shares for each call that you sell. You wager that the stock price will stay the same or slightly decrease. If it rises above the exercise price by the expiration date, you have to sell the stock to the call buyer for the exercise price.
Covered call example
- You own 100 shares of Company A at $50 per share.
- You sell a call option on these shares with an exercise price of $55 and receive a premium of $3 per share, which amounts to $300.
- Upon expiry, the stock price is below $55. You keep the premium and your stock, resulting in a profit of $300.
3. Short Put
In a short put strategy, you sell a put option because you anticipate the stock price to be higher than the exercise price when the contract expires. The most you can earn for selling a short put is the premium. If the stock price is lower than the exercise price at expiration, you have to buy the stock at the exercise price.
Short put example
- You find a put option that expires in two months with an exercise price of $65.
- You sell the option contract at the exercise price.
- The premium is set at $2 per share, and the contract covers 100 shares, so you receive $200.
- The contract expires, and the stock price is above $65.
- You keep the entire premium, leading to a profit of $200.
4. Long Put
The long put is the opposite of the short put. When the contract expires, you buy a put and wager that the stock price will exceed the exercise price. You can make a profit should the stock price fall below the exercise price.
Long put example
- You buy a put option with an exercise price of $70.
- You pay a premium of $3 per share ($300 total) for the right to sell the stock at $70 if the option is exercised.
- The stock price falls to $60, so you sell it at the exercise price.
- Your profit is the difference between the market price and the exercise price ($10), multiplied by 100 ($1,000) minus the premium ($300), which is $700.
5. Married Put
The married put involves buying a long put on stocks you already own to insure yourself if the price of your stocks falls partially.
Married put example
- You own 100 shares of a company at $60 per share.
- You buy a put option on these shares with an exercise price of $55.
- The premium is $3 per share ($300 total).
- The total investment is the initial stock cost ($6,000) plus the $300 premium, which is $6,300.
- The stock price is lower than $55 at expiration. You sell the stock at the higher exercise price of $55.
- This limits your maximum losses to the difference between the stock’s cost and the exercise price ($5), multiplied by 100 ($500) minus the premium ($300), which is $200.
Options trading opens the door to a thrilling and dynamic realm of financial markets, where astute investors employ strategies to maximize returns. This guide has explored five essential options trading strategies, providing insights for seasoned traders and those venturing into the options market.
