Trading options is an effective way of investing and generating money in the short and long term. However, if you want to start investing before you go into options trading, you need to be familiar with how it works and what strategies to implement for success.
By learning how to trade, you will minimize the risk, as well as take advantage of the flexibility of options trading.
In this article, we will go in-depth about options trading strategies and discuss how to make the right investments based on market prediction. Let’s begin!
Options Trading Strategies
There are multiple options trading strategies that every trader should know, no matter if they are just beginners in trading or advanced traders.
Although there is potential to make a lot of money and really fast, options trading is risky, so you will need to educate yourself before you start putting your hard-earned money on the line.
In this article, we will familiarize you with some of the most popular options strategies, in order for you to maximize returns.
Options Trading Briefly Explained
What exactly is options trading?
Before we start discussing the strategies, let’s briefly talk about what exactly options trading is. Options trading is the practice of trading options contracts that give you the right to purchase or sell a specific stock on a certain date for a certain price.
It enables the investors to speculate about the flexibility of the market and the direction the stocks will go in the future.
In other words, the contracts give the holder the right without an obligation to purchase or sell an underlying asset at a specific set price if the asset moves beyond the price in a specific timeframe.
There are two types of options trading: call and put options. The call option means the trader has the right (but not an obligation) to buy shares of stocks at an agreed price on or before a particular set date.
And the put option gives the trader the right without an obligation to sell shares of stocks at an agreed price on or before a particular previously agreed date. The agreed-upon price is called “a strike price”. The particular date is the time at which the option contract will expire.
Advantages and downsides of options trading
Among the advantages of options trading is that it offers flexibility and liquidity, allowing you to invest a small capital as opposed to other investment options. If done properly using the right strategies, options trading can earn you a lot of money, really fast.
However, it can also be risky and requires predicting stock market movements. Therefore, it is important to implement the right strategies depending on how much you are willing to risk and what your investment goals are.
Being Familiar With Different Options Trading Strategies
Learning all the options strategies for beginner, intermediate, and advanced traders is very beneficial for successful trading. The reason for this is that they provide a way to potentially make a profit irrespective of the market situation.
An important thing to state is that to begin trading, you don’t have to own a stock. Instead, you can only trade the fluctuating option prices using your brokerage account in the same way you would have started trading stocks.
Options Trading Strategies Every Trader Should Know
Now that you are familiar with how options trading works, let’s get into the details regarding the strategies you can implement.
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Bullish options strategies
Bull call spread
This options strategy involves buying calls at a certain strike price and selling the same amount of calls at a higher strike price. The calls need to have the same underlying stock and expiration date.
To implement this strategy accurately, you will need the stock to increase in price so that you make a profit. On the contrary, a loss in trade occurs when the stock price falls and is equal to the net debit.
Bull put spread
When you believe that the underlying asset's price will moderately increase in a short period of time, you will need to go for a bull put spread options trading strategy. It works similarly to the previous strategy, but instead of buying calls, you will buy puts.
The spread features both selling a put option and purchasing a put option at a lower strike. An important thing to note is that both puts should have the same underlying asset and expiration date.
A profit occurs from the rising stock price, which is limited to the net credit you receive, while a loss happens when the stock’s price falls below the strike price.
Synthetic call
If you are in for a trade offering unlimited potential profit and limited risk, then this strategy is for you. To execute a synthetic call, the process involves purchasing put options of the stock you are holding.
If the price of the underlying stock starts to rise, you will earn a profit, whereas if it falls down, the loss is limited to the premium that is paid for that particular put option.
This strategy requires buying an ATM call option and selling an ATM put option. Moreover, you will need to ensure that the options belong to the same underlying asset and have the same expiry date.
Neutral to bullish strategy
Call ratio back spread
This is the simplest options trading strategy. A call ratio back spread enables the traders to make a profit when the market goes either down or up.
Simply put, as a trader, you make an unlimited profit when the market is up and a limited profit when it is down.
Trade loss when it comes to this strategy happens only when the market is stagnant.
The strategy consists of buying two out-of-the-money call options and selling in-the-money call options.
Such a strategy is deployed when the trader is bullish on a stock.
In terms of the call ratio back spread, the money goes into your account once you implement this strategy, and the “net credit” is what you will make when the market goes down compared to your expectations. If the market does go up, you will get an unlimited profit.
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Bearish options strategies
Bear call spread
This two-leg options strategy is intended for traders with moderately bearish views of the market.
The method involves selling a short-term call option and, at the same time, buying a long-term call option with the same underlying asset, expiration timeframe, and a higher strike price.
If you get a higher option premium on the call that you sold than the cost of the call that you have purchased, you will gain a profit.
Bear put spread
The bear put strategy is effective if you predict an asset's price will decline, but only moderately.
Purchasing an ITM put option and selling the OTM put option at a low target price results in a bear put spread strategy.
Again, both puts should have the same underlying stock and expiry date. The strategy makes a profit when the underlying stock falls in price.
Synthetic put
This strategy is designed for investors with a bearish view of the market and are concerned about the potential strength of the stock.
The profit is then made when there is a decline in the underlying stock price, hence the name “synthetic long put”.
This strategy is similar to the long-put option as it involves holding a short stock position and a long call option on the same asset.
Bearish to neutral strategy
Strip
If you are an investor that is bearish in the direction the market is going, you can employ the strip options trading strategy. It involves buying one ATM call and two ATM puts.
When it comes to this bearish to neutral strategy, the trader earns a profit once the price of the underlying asset moves up or down on the market at the time of expiration.
The maximum profit is unlimited, while the total loss is limited to the paid net premium.
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Neutral options strategies
Neutral strategies are the ones whose profits don’t depend on the market direction.
Long straddle
This is a strategy that involves purchasing ATM call and put options. When it comes to long straddle, a profit is generated as long as the market is moving.
As a trader, you will also need to ensure that both the call and the pull options are on the same underlying, belong to the same price strike, and have the same expiry date.
For the long straddle strategy to be profitable, the volatility should be relatively low when the strategy is executed but should increase during the holding period.
Short straddle
In comparison to the long straddle strategy, the short straddle involves purchasing ATM calls and put options.
In this strategy, both the profit and the loss are limited. It is set up for a net credit, so when you make a sale, you receive the premium in your account.
Long Strangle
The long-strangle options trading strategy is a strategy in which the OTM put options and the OTM call options are purchased simultaneously. This is a frequently used method by traders as it comes with a low risk but a high payoff potential.
The long strangle strategy is suitable when the trader is expecting high volatility in the underlying stock. When the underlying moves up and down upon expiration, the maximum loss is the net premium paid, whereas the profit comes when the underlying moves in any direction.
Short Strangle
On the other hand, the short strangle method involves selling a put and a call OTM options. This is a strategy with the goal of improving the profitability of the trade for the seller.
Long and short butterfly
The butterfly spread combines the bull and the bear spreads. That said, this strategy comes with a fixed risk and a limited profit.
The long butterfly method involves buying one ITM call option, writing two ATM call options, and buying one OTM call option.
The short butterfly strategy includes selling an ITM call option, purchasing two ATM call options, and selling an OTM call option.
Long and short iron condor
This is an options strategy involving two puts and two calls as well as four strike prices with the same expiration date. In such a case, the profit comes when the underlying stock closes between the middle strike prices.
This method enables traders to manage their capital efficiently as it has defined risk.
The iron condor is created from a short vertical put spread and also a short vertical call spread in one transaction.
Additional Options Trading Strategies
Covered call
This strategy involves selling a call trade option and buying the underlying stock, which is 100 shares for every call that you purchase. In this situation, the trader expects the stock price to be below the strike price at the expiration date.
However, if the stock moves above the strike price, the holder needs to sell the stock to the trader that bought the call at the strike price. This is a good strategy for earning a return when you already own the stock and don’t expect it to rise at any time in the future.
Married put
When it comes to the married put strategy, the trader owns the trading stock and purchases a put. This strategy is to be implemented when you expect the stock to rise soon, but you want to have insurance in case the stock falls.
It is made of two parts: purchasing 100 shares of a stock and buying a put option with the same underlying at the same time.
Collar option
This strategy includes buying or owning the stock and buying a put option at a specific strike price, as well as selling a call option at a particular strike price. This is a method to consider if you are bullish on the stock but have concerns about potential downward movement.
This is a very useful strategy as it gives the investor the ability to limit potential loss in case the stock starts trading down.
Intraday Options Trading Strategies
To trade options intraday, you will have to look at chart patterns and pick the option contracts you think will be making a move.
There is a lot of nuance involved with which contracts to pick, every trader is different, but I like to look for contracts expiring one week out.
The most popular chart patterns to trade options intraday are:
Momentum strategy
Momentum trading, as the name suggests, is looking for stocks that have momentum during that day.
Stocks gain momentum from news, earnings, or events.
The momentum could be to the upside, or to the downside.
Momentum traders look to find these stocks and ride the momentum in the right direction.
Breakout strategy
When you buy and sell options, the main factor for success is the right timing.
As the name states, the breakout strategy should be executed when you find the stocks that have broken out from either support or resistance.
You will need to determine support and resistance points when the stocks are about to trade at a new price range.
Then, if the stock prices rise above those resistance points, you will enter long positions, whereas if they go below the support points, you will be entering short positions.
Reversal strategy
A reversal strategy is when you wait for the stock to make a reversal to the opposite direction.
For a bullish reversal, you will find a support point, then watch the stock go down to that point, and if the stock shows signs of bouncing, you enter a long position.
A very common thing that happens when a stock is going to reverse to the upside is a hammer candle. If you see a hammer candle at support, you found your reversal.
For a bearish reversal, you will find a resistance point, then watch the stock go up to that point, and if the stock shows signs of reversing down, you enter a short position.
A very common thing that happens when a stock is going to reverse to the downside is a shooter candle. If you see a shooter candle at resistance, you found your reversal.
Scalping strategy
Scalping is when you profit off very short term price movements in both directions, usually trades are not held for more than 15 mins.
Scalpers often use option contracts expiring the same week, because these are more volatile, and allow them to make decent returns with very small price movements.
Most scalping strategies involve using indicators on lower time frame charts. The most popular indicator for scalping is the VWAP indicator.
Moving average crossover strategy
Moving average is an indicator that calculates the average price of a stock. The indicator is shown on the chart as a line.
There are different moving averages, for example the 9 moving average (referred to as 9 MA), calculates the average price of the last 9 candles.
And the 7 moving average (referred to as the 7 MA), calculates the average price of the last 7 candles.
When the stock prices move above or below average, it is an indication of a change in momentum.
Once the prices rise, the situation is called “an uptrend” and requires entering long positions and buying stocks.
However, when they are lower than the average, it is called “a downtrend” and requires entering short positions and selling the stocks.
Gap and go strategy
This strategy includes stocks that gapped either up or down in the pre-market.
“Gapped” means there is a gap between the opening price and the closing price that was available the previous day.
Hence, when the stock's price opens higher than yesterday, it is known as a gap up, whereas, in the opposite scenario, when the stock opens lower, it is a gap down.
Gap and go means that if the stock gaps up, you go long with calls.
If the price goes down, you go short with puts.
Begin Trading Successfully
Once you are familiar with the strategies for options trading, you can start investing. A positive thing about options trading is that it doesn’t require too much money to start.
If you are a beginner trader, what is recommended is to start with only a few hundred dollars and grow wealth over time by using the right trading strategies.
That said, to be able to view the options chain and all the available options, you will need a suitable trading platform.
Trading service
To become a successful trader, you are required to constantly analyze the market and make the necessary movements at the right time.
If you want to stay on track and be alerted about the changes in the market, it’s recommended to use a service such as FoolProof.
FoolProof enables you to learn the basics of options trading as well as advanced strategies from veteran traders. With the help of artificial intelligence, you will receive three alerts per week in the form of a message.
Moreover, you will be able to note the strike price and the options trading types and even get suggested trading ideas.
The team of veteran analysts behind FoolProof will find trades and stocks about to make market moves and send you a trading plan through Telegram. The service provides thorough guidance, so it is suitable for both beginners and advanced traders who want to improve their trading experience.
You can get all these benefits and more for only $97 per month and get a free 14-day trial to try it before making a purchase.
Final Thoughts
Given all the facts about options trading strategies, the conclusion is that options trading enables one to earn a good amount of money in a short time period.
However, options trading requires extensive knowledge of the trading process and experience, including implementing strategies to earn profit and minimize risk.
You can subscribe to the FoolProof service so that you can be informed of every change on the market at the right time.
Many traders opt for options trading as the stock market fluctuates and poses a great risk, and use options like buying insurance and limiting losses.