Options trading is one of the useful forms of trading for the traders who seek to enhance their revenues and manage the risks. Nevertheless, finding oneself in a world of options is very challenging provided that you are entering this world for the first time.
Here are the 7 best option strategies that every trader should consider and they are as follows: These strategies can be adjusted to the specific conditions present in a certain market, which should aid in making more rational decisions.
1. Bull Call Spread
The Bull Call Spread is a standard option trading strategy ideal for traders that are bullish on the future of a given stock but wish to cap their risk. It is a process whereby one can purchase a call at a particular strike price at the same time selling another call at a higher strike price. There is no difference in their attributes and characteristics as they are of the same type and both of them will expire at the same time.
Why It Works?
Risk Limitation: Of course, like in any investment, the profit is limited while the loss is equally limited too. This makes it invariably more appealing for those who are optimistic on the prospects of the company but are also inclined to manage their risks.
Cost Efficiency: The second call is equally useful in offsetting the cost of acquiring the first call and thus, requires a smaller amount of investment.
Insight: According to the results, Bull Call Spreads are most profitable in the moderately bullish environment when the stock prices are most likely to increase steadily.
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2. Bear Put Spread
For those who have a bearish outlook on security, then the Bear Put Spread is one of the best option strategies. This entails entering into a put option at a particular strike price while at the same time selling another put option, the strike being at a lower price compared to the first one but with the same expiry date.
Why It Works?
Controlled Risk: Just like in the Bull Call Spread, the profits and risks are somewhat limited here, and this strategy is therefore most suitable for bear markets.
Cost Reduction: Second put selling brings down the cost of the option itself because this option strategy is constructed at the purchase price of the first put.
Insight: Although analysis of the historical data also revealed that Bear Put Spreads are the best when the stock market is gradually declining.
3. Long Straddle
Long Straddle option trading strategy is used by traders when they expect big price movement of a security but do not know the direction to expect. It is a strategy in which an investor simultaneously purchases a call as well as puts with the same strike price and same expiration date.
Why It Works?
Profit from Volatility: This option strategy enables you to earn from a large volatile movement in the price in one direction or the other.
Market Neutrality: Since the direction does not matter, it does not matter which direction the market is moving in as you are protected in either case.
Insight: This strategy should be used when the value of stock is most likely to be volatile especially before earnings releases or key economic indicators.
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4. Iron Condor
The Iron Condor is considered as an extra-advanced strategy that entails selling off an out-of-the –money call and put option while simultaneously buying a further out-of-the money call and put option. It is important to note that the expiration of all option contracts is the same.
Why It Works:
Profit from Stability: This option strategy proves useful in premises that are not characterized by steep changes in price levels.
Limited Risk and Reward: Profit that can be obtained is relatively small, the exposure that you have for the loss is also relatively small, so it is not a risky plan.
Insight: This not only includes the fact that during previous occurrences of market conditions, Iron Condors proved to be most efficient when the market volatility is low.
5. Covered Call
A Covered Call is defined as the overall process of owning the physical stock, and at the same sell a call option. Due to its safety, this option trading strategy is favored by conservative investors aiming at earning income.
Why It Works:
Income Generation: The selling of the call option brings in cash which may reduce any loss on the stock.
Limited Downside: If the share price goes down the premium that is received from selling the call acts as an offset.
Insight: Again, Covered Calls are commonly used by long-term investors when they are in a stable or slightly bullish market in order to get extra income.
6. Protective Put
Protective Put strategy requires purchasing of a put option on a specific stock that you have an existing position in. It is similar to paying a premium for insurance for the stake you are owning in business.
Why It Works:
Risk Management: The put option also controls the possibility of a lower value stock price because the maximum loss will be the cost of the option and the difference of the strike price of the put option and the stock price.
Flexibility: You can have any upside in the stock since the put is triggered only by a decline in the stock price.
Insight: The Protective Puts are particularly useful when there is an existing unstable situation on the stock market or when we have a long-term position on an especially fluctuating stock.
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7. Strangle
A Strangle is like a Straddle but in this case the buyer purchases a call with a higher strike price and a put with a lower strike price. This is the option strategy that traders use when they anticipate that the price of the commodity will move, but there is no way of knowing which way it will go.
Why It Works:
Lower Cost: Due to the fact that options are bought out of the money, a Strangles costs less than a Straddles.
Profit from Big Moves: This option strategy benefits from huge differences in the price levels in the same fashion that Straddle does, although it does it with senseless trading.
Insight: Some common events when Strangles are used are when the event is certain to bring a large amount of volatility such as elections or interest rate decisions.
Conclusion
It’s important to gain some insight about the 7 best option strategies that could be of help while dealing with the various complexities of the market. In this case, each option trading strategy has this advantage or that one over the other depending on the current market status and desired results in the investment.
No matter if you are optimistic and believe that the market will rise, pessimistic and expect it to fall, or unsure about the further development, there is an option which can minimize risks and increase your income.
Like with most investment plans it is essential to understand all the risks associated with it and to use such strategies as additional tools in investment management.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.
7 Best Option Strategies Every Trader Should Know