Options trading strategies for beginners
Every trader has at least one goal in common; make money. And learning the different options trading strategies will provide you with the information you need to achieve that goal. Therefore, take the time to review the top seven options trading strategies listed below. In fact, the way you build wealth every day can change forever.
There are many strategies available to traders. But let’s learn the basics first and soon you’ll be ready to tackle the more complex strategies. So let’s get started …
Understand options trading strategies
1. Extended call – Capture outsized gains with higher stock prices
This is one of the favorite strategies of bullish traders. This means that you are betting that the stock price will go up and that you will do so by buying calls. Call options are contracts that give the holder the right – but not the obligation – to buy stocks at a certain price. It’s basically a bet that the price of the underlying stock will exceed the strike price of the option and the contracts will give their owner the ability to buy at a discount. When this happens, these calls are called “in the money”. If the strike price of a call option is greater than the price of its underlying security, it is referred to as “out of the money”.
Let’s use stock “X” as an example. A trader is betting that X shares will exceed $ 250 per share on the third Friday in July. The more the stock price exceeds the strike price, the more money the trader will earn.
For this hypothetical example, let’s say the X share is trading at around $ 248, just below your strike price of $ 250. The July 15 options at $ 250 are trading at around $ 4.35. This means that X’s stock would have to be at $ 254.35 for the trader to break even. So let’s say you got locked out and news of a new product falls the day after the trader bought their calls. This news sent X’s share price soaring to $ 256.35. This means that the trader has crossed his breakeven point of $ 2 and his options are now worth $ 6.35.
That’s good for a 45% payout (you entered the calls for $ 4.35 and they went up to $ 6.35). This is an example using intrinsic value to show you how you can profit from being long in a call option. In many cases, a large increase in the stock can give you even larger moves in options. As a result, you can get bigger returns.
2. Long Put: How To Profit From Downward Stock Movements – With Less Risk Than Short Selling
It is one of the preferred options trading strategies for bearish traders. This means that the trader is betting that the stock price will go down. A put works unlike a call. If the strike price of a put option is greater than the market price of the stock, it is in the money. If the strike price is lower than the market price of the share, it is out of the money. And if a trader buys a put option, he or she expects the stock price to fall below the strike price upon expiration. Puts give the holder the right – but, again, not the obligation – to sell shares of a share at a certain price.
Again, let’s use stock “X” as an example. And the trader takes into account X’s current price of $ 248 and buys put options that expire on July 15 with a strike price of $ 247.50, for a premium (cost) of $ 5.20. For these puts, their breakeven point would be $ 242.30. As for the calls, but in reverse. If stock X goes below this breakeven point, the trader will profit. Suppose news of a scandal breaks out and the X share price drops to $ 238 within days. The put traders would climb to $ 9.50. As a result, they could sell them for a gain of 82.7% and a profit of $ 4.30.
Two-part trading strategy
3. Covered call: unlock additional income through your actions
Choosing the options trading strategies that are best for you can be difficult if you are not familiar with all of the types. So let’s continue with a two-part strategy known as a covered call.
This strategy requires the lowest level of authorization from your broker and can be applied to any type of account. It also requires the trader to own shares of the underlying stock (100 shares for each option contract). It is important to note that the trader sells to open calls against his position.
They will buy one share, at least 100 shares, and sell an option against their holdings. When a trader does this, he reduces his cost by the option premium received. In return for this reduction, they also limit their upside to the strike price of the option sold.
For example, if you buy the “Y” stock for $ 10 and sell an option with a strike price of $ 12 for $ 1, your cost is now $ 9. However, your benefit is limited to the difference between $ 9 and $ 12. If the shares expire below the option strike price, you keep the share and the option premium. If the shares are above the price at or before expiration, the shares can be called or withdrawn from your account as long as you receive the strike price. Writing a covered call involves selling an option for a stock you already own. It generates income while you hold it. This is a great strategy for income seekers.
4. Bull Call Spread: opt for a long position at a lower cost
A bullish buying spread is the simplest type of spread. It is often called a vertical call gap. For this strategy, you would buy a lower exercise call and sell an upper exercise call. It’s very similar to doing a covered buy trade with a stock where you buy the stock and sell an option against it.
The goal is to reduce your costs by selling an option against the option you bought. The options can be very expensive and this is a way to keep your costs down. The bullish call spread or vertical call spread occurs when you bet on the price of a stock that is going up. When you bet the stocks will go down, you will be using a sell down spread. This is also known as the vertical spread, which I explain in more detail below.
5. Bear Put Spread: reduce your hedging costs
A bearish sell spread is the same concept as a bullish buy spread. But instead of using calls, you are using put options. You buy a put at the higher strike price and sell another put, with the same expiration date, at a lower price.
Say you buy a $ 10 put for $ 2 and sell a $ 5 put for $ 1. Your cost would be $ 1 and your spread would be $ 5. You bet the shares will go to $ 5 or less to collect the full spread. But, any move less than $ 9 will result in a profit.
If the stock was at $ 20 and you expected it to drop to $ 15, you would buy to open the $ 20 exercise option and sell to open the $ 15 exercise option. If the $ 20 put was $ 3 and the $ 15 put was $ 1.50, your cost would be $ 1.50 and your spread would be $ 5.
This strategy is not a pure short position. It’s a hedge, which means you have to have long positions that you are trying to protect. Since this strategy is a spread, your losses will be limited as the long and short sides of the trade will decrease. This strategy should only be used if they understand how a hedging trade works.
Two-way winning options trading strategies
6. Long Strangle: Win no matter how a stock goes.
A choke is one of the most popular and best applied strategies in situations where the underlying stocks are volatile and prone to rapid movement in either direction. Its sister strategy is called a straddle, which I’ll explain in a moment. This strategy allows you to make profits regardless of the direction in which the stock moves, as long as a stock moves by a certain amount in both directions. A trader will buy an out-of-the-money call option and a put option at the same time with the same expiration date. However, they will have different strike prices. The put strike price must be lower than the call strike price.
Let’s say you are looking for shares of Company “A”. It is currently trading at $ 15. But it’s incredibly volatile and a profit announcement is coming that could really shake the stock. As such, you think it could quickly drop to $ 5 or climb to $ 25. You would be looking to buy put options with a strike price below $ 15 and calls with a strike price above $ 15.
You find two perfect ones, put options with a strike price of $ 10 and calls with a strike price of $ 20. You will need Company A to drop to $ 8 or increase to $ 22 to break even. However, any move above $ 22 or below $ 8 will earn you the profit you are looking for. So let’s say the stocks go down to $ 5 like you expected. You would win $ 5 minus the $ 2 you paid for the put and call. That would be a net return of $ 3, or 150% on the entire transaction.
The same would be true if the share price rose to $ 25. Throttles are best played around the earnings season, which is when companies are reporting profits. And these reports can cause stock prices to fluctuate sharply. Now let’s get into the last of the top seven options trading strategies that every investor should know.
7. Long stride: movement up or down… you win
Overlaps and bottlenecks are two strategies that allow a trader to benefit from the rise or fall of a stock. So let’s see what is the main difference between these two strategies. A straddle is very similar to a strangle, in that an investor will buy a call option and a put option at the same time. But both options should have the same strike price AND the same expiration date.
In an overlap, you’ll usually get something back (unless they pin it exactly on your strike). The bottlenecks and overlaps are largely up to the investor to decide what suits their personal style and trading needs.
The bottom line
The main benefit of options is that they give you leverage in the markets to help you maximize your earnings. There are a variety of options trading strategies that investors can take advantage of. And today you have learned some of the most popular. Take the time to learn the process and soon your goal of making money will come.
Now that you know the basics, you are ready to continue on your trading journey. There’s no better way to do this than by signing up to receive Trade of the day. It’s a FREE e-letter providing information on the latest and greatest stocks, investment opportunities, options trading strategies and more… Subscribe below to receive this premium content straight to your inbox!