Option Trading Strategies: From Basic to Advanced

option trading strategies

If you wish to join the ranks of options traders, then congratulations – you likely traded long enough to figure out what options are in essence. It means that you probably have enough understanding of trading to start betting on asset-backed contracts rather than assets themselves.

However, it’s a bit different from just buying low, selling high. Options have additional requirements and rules, and they make this sort of trading perilous, in addition to promising. There are many option trading strategies: some offer quick and small gains, while others are lengthy and lucrative.

So, what are the different option trading strategies? We’ll know in a sec.

What are the options, briefly?

You likely already know what options are, more or less. However, it would still be useful to clear some things up, in addition to just mentioning several key aspects so that we could freely reference them later.

They basically allow you to purchase or sell certain assets at a later date, although you can also not do that, hence the name. These contracts have several things set in stone:

  1. A strike value – the fixed price at which the assets are to be bought/sold;
  2. Expiry date – a date that shows the day when the contract becomes null. Basically, you ought to make a choice before the day;
  3. The asset – you can only buy or sell assets that underlie the contract, with no other choice.

While completing your contract is up to you (for both kinds of agreement), you still need to pay a premium, which makes these contracts not as easy to handle as it might seem. The premium depends on the distance between the strike price and the current price, as well as the quantity of assets you’ll be able to buy or sell.

Speaking of the main types of options: there are call and put. The former enables people to purchase stuff, and the latter – to sell it at a specific value (strike price). There are naturally more types of options, but they aren’t particularly important at this time.

So, now that you remembered what options are, let’s see what option trading strategies have a high probability of success.

1. Long Call Strategy

This approach is used most widely on all markets. A trader buys an option granting the ability to purchase assets later, and banks on the actual price rising above the option’s strike price. What it means is that they can now buy the assets and sell them at a higher price.

The price can obviously climb higher than the strike price, and at that point, it’s only reasonable to abandon the option. The only loss you’ll have to suffer is the premium, and that’s a tolerable loss. There are option trading strategies that force you to pay for more than just the premium.

So, your primary objective in any of these strategies is to make sure your strike profits can offset the money lost as premium. You can do it rather freely in one of the many option premium calculators online.

2. Long Put Strategy

That is another basic approach. It works much like the long call, except you wager on the value decline while being able to sell stocks at a determined strike price if you want to.

The objective here is to make sure the actual asset value upon your planned redeeming date is lower than the strike price. If it is, then you’re welcome to purchase assets at this lower price and use your option to sell them at a strike price. The remaining funds are your profit in this case.

If the market price turns out above strike value, it means you’ll have to forfeit the contract. The rules are the same – you’ll still have to pay your premium regardless of what you do.

3. Short Put Strategy

A Short put is a bit more complex than the other two. It’s essentially a way to quickly receive a payment via a premium that the other side is bound to give to a seller (which is you). The seller’s hope here is that the market price at the expiration date will be higher than the strike value.

Since the buyer on the other side will surely refuse to buy a stock only to sell it for cheaper, the deal will be aborted. However, the seller will be left with the premium. Therefore, you can count on a fixed income, but only if the asset value rises above the strike price.

If it doesn’t, then the seller will have to acquire stocks to provide them at a strike price, which is higher. In short, it’s a risky but a sure way of collecting money.

4. Covered Call Strategy

A covered call strategy is one of the many hedging strategies options are so useful for. It’s basically a double play where you buy a small-moving asset in a long trade (expecting it to rise in value), while also simultaneously selling a call option of the opposite nature.

The strike price on the call option is supposed to be set at a much smaller price than projected. So, according to this option, you actually expect the assets to plummet in value. This way, you’ll receive a premium, and the deal will be aborted because the asset suddenly dropped in worth.

However, that’s actually a sort of risk management. If the price on the asset actually drops, you’ll be able to slightly offset the losses with a premium. Your actual goal here is to see it rise in price, though. It’s the only way to achieve profits. 

It’s true that the failed call option will eat up some of your capital because you’ll be forced to buy at a higher price. However, it means you’ll receive steady (if small) profits and be relatively safe from the dangers of sudden price drops.

5. Married Put Strategy

A married put is rather similar to the covered call, except it’s even more about containing risks rather than earning a steady income. Married put implies an acquisition of a selling contract alongside an underlying asset of the same volume. 

The asset is put into the usual long position. It’s expected to grow in price and thus bring gains. The contract, ‘married’ to stock, instead has a strike price much lower than the expected market price of the asset. This ensures that, even if the asset fails, the put acts as a cushion that significantly decreases the losses.

The main objective, of course, is for put to fail. It’s just the insurance. Although you need to pay for it when it fails, these losses are tolerable. If the stock continues to rise, you will rip gains that will far outweigh the losses inflicted by a failed contract. In essence, you get a slightly lower income, but with fewer potential risks.

6. Bull Call Spread Strategy

At this point, the strategies start to demand more management. Although this technique isn’t particularly advanced, it still requires expertise and tricky handling, especially in the costs department.

A Bull Call Spread is brilliant if you expect an asset to moderately rise in value (but not too much). The problem with betting on such small fluctuations is that the premium is usually much steeper the closer your strike value gets to the current market price. That’s why you need two options.

The other option is a sold put option, which basically gives someone other than you the right to purchase your shares. If the price will only rise moderately like you believe, this second option will be abandoned because its strike value would be above the stock value upon the expiry.

The second option was ever only meant to collect premium from an aborted deal. Since the strike price on this contract is much higher, the premium is much smaller. Still, it’s enough to significantly offset the steep costs of the first contract. What you basically do is buy a call option at a much smaller cost than usual.

This strategy normally makes for a very limited, albeit safe income. If you’re absolutely sure there won’t be sudden price moves in the near future, then you can go for this one.

7. Bear Put Spread Strategy

This strategy is a complete reversal of the previous one, although it works by the same principle. The only difference is that it’s a bearish strategy that preys on the price decline rather than growth.

Essentially, you purchase and sell one selling contract each at the exact same volume and at the exact same expiration date. This will only work if you expect the price of the assets to moderately decline, which would enable you to get a premium for the second option and redeem your first contract.

Like in its bullish counterpart, the main objective here is to offset the premium on the contract you intend to redeem. This will provide a steady source of income, while also lowering the risks.

8. Bull Put Spread Strategy

A Bull Put Spread strategy combines both techniques from above, but in its own, creative way. Puts are usually good for the bearish trends because their own value decreases as the asset’s price increases. In this instance, however, the price needs to rise in order to create any profit.

The premise is as before: one contract has a higher sale value than the other. In this case, the lower strike price belongs to the put option you bought, and the higher – to the one you sold. Both are needed to expire worthless, and what money remains after you deduct one premium from the other becomes your gains.

Like the previous two, this strategy is good if you’re sure the price of the underlying asset is going to rise moderately in the near future. Here, however, it happens for a different reason: there are simply better strategies to use if you know it’s going to rise significantly.

This is still a rather steady and low-risk source of income, except it’s a bit riskier and a bit more lucrative than its two cousins.

9. Long Straddle Strategy

A Long Straddle is a strategy that allows investors to rip profits from extreme price fluctuations in the areas of high volatility. With it, the trader buys both a put and a call option, which allows covering each price destination. It’s perfect when it’s evident that the price will make a lengthy move, but it’s unclear as to where.

In the course of this approach, the put option is supposed to be given an extremely high strike price. The call option, by contrast, needs as low a strike price as possible. As a result, wherever the asset’s price would go, it would be caught in one of the two nets you set for it. That is if it indeed dramatically fell or grew in price. 

If it only did so moderately, and the expiration date is already up, then both contracts were a failure, and you have to pay costs for each. If one succeeds, then the massive profits from it can offset the costs of the other one easily.

That’s why you need to be sure that there is going to be a massive price surge/fall. But other than the costs (and maybe some unexpected losses), you don’t really need to worry about the risks with this one.

Summary

The option trading strategies are versatile, and they include both low-risk and high-risk strategies. If you have an accurate understanding of the coming price fluctuations, you’ll actually be very well off with some of these low-risk strategies. They are only low-risk if you know exactly what the oncoming price movement is going to be.

For this reason, option trading is not particularly advised to beginners. This niche requires at least some expertise and experience. If you think you have both, then you’re welcome to try options trading. It’s a genuinely creative pastime, seeing how various contract combinations can unite into cunning formations that earn money 90% of the time (even though it’s mostly limited gains).

The good thing about them, though, is that you can still participate even if you’re new to the trading because there are several simple strategies that promise good winnings at a moderate level of risk.

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author

Carolyn Huntington is an economist, professional trader, and analyst. She made her first big deal in her student years with a profitable investment in Facebook stock. Now the total experience of her trade is 18 years. Over the years of trading, Carolyn has developed its own strategy that allows even those who have never traded on the stock exchange before to earn money. She also creates market forecasts and advises major shareholders, compiles investment portfolios, and teaches how to work with automated advisors.

telephone: 503-547-5192