Perhaps one of the most confusing trading strategies for beginners, options require a bit more planning than simply clicking the buy or sell button. A bit like futures, you’re not actually buying shares of a company. Options are a contract.
WHAT ARE THE OPTIONS?
Options are just that, the option to buy a certain amount of shares of a stock at a specified price. It is essentially a contract, albeit instantaneous, between buyer and seller, for a certain number of shares (usually 100 per contract) at a predetermined price (clash) to be executed by a certain date in the future (expiration).
On the expiration date of the contract, you have the right to allow the option to expire or to exercise your right to shares at whatever price the stock is currently trading.
Here’s an explanation of how it works in what we’ll call a basic naked calling option.
XYZ shares are trading at $10. You expect the stock price to rise to $20 over the next 6 months. Looking for options with a “strike” price of… $12, just above the current price of $10. The expiration date will be a few weeks or months.
If the stock price exceeds your strike by $12, you’re in the money. However, to start the option, you have to pay a “premium”. A reward is a fee charged by the options desk (writer) of the contract. It is quoted as an amount in dollars per share and each contract usually contains 100 shares of the underlying stock.
The premium price can range from around $1 to $10, (or more) on popular and volatile stocks like Tesla or SPY. This premium you pay gives you the right to the contract. To understand the math: if you bought 1 TSLA option contract for $10, it would cost you about $1000 for the prize.
1 option contract = $10/share
100 shares per contract x $10 = $1000 premium
LIST OF OPTIONS TRADING STRATEGIES
There are many different options trading strategies to choose from. In fact, names get pretty creative. To this end, there are many types of spread options, covered options, married options, strangle and straddle options, etc.
Naked Calls and Puts options strategy
When you want to bet on the long side of a stock using options, you have two choices: buy calls or sell puts. If you want to bet on the short side of a stock movement using options, buy put or sell calls.
As part of this process, if you don’t already have a position in the underlying stocks but want to buy or sell options, you’re going “naked” on calls or puts. One advantage of this strategy is that it limits your risk only to the premium you pay for options.
This does not mean that you do not have any risk. After all, when an options contract expires without exercising your right to buy the shares, you will lose the entire premium you paid. However, as we discussed earlier, it can be an easier way for smaller accounts to harness purchasing power by limiting their risk.
Here is an example of this using TSLA. If you have a $5,000 account and want to purchase a TSLA contract at a premium of $10/share. In total, you will pay $1000 for the contract. If TSLA rises in price and reaches or exceeds the strike price before expiration, it is very possible to double the premium.
This, of course, is a very simple example and will have many determining factors that can affect your premium – things like decay, volatility, etc. But, for all intents and purposes, it is at least an options trading strategy and perhaps the easiest.
Covered calling options strategy
A covered call is an options strategy that allows you to buy a stock and sell (write) a call option at the same time.
That’s how it works. At the same time, you buy shares of a share, you automatically sell a call option on the same shares at a higher strike price. Why would you, you might ask? Essentially, to collect the premium from writing calls in addition to selling your shares.
You’re protecting your initial investment on buying the stock by selling call options and collecting a premium. The only caveat is that you must be willing to sell the shares you bought at the short strike price of the call. When options are exercised, you will have collected your premium and sold your shares at the strike price.
Put Options Strategy for Married
A married put is very similar to a prenuptial agreement. No pun intended. It allows an investor to use options trading to hedge his downside risk when buying stocks.
It works like this: you buy a certain amount of shares and then buy put options for the same amount of shares. As you may recall earlier, buying puts is a bet that a stock will go down. In case this happens, you are trying to hedge your long position from any catastrophic P/L swings.
However, if the stock price goes up, you will only lose the premium you paid for put options.
Bull Call Dissemination Options Strategy
A bullish spread strategy is an options trading strategy for the same underlying asset, with the same expiration date. However, one call option is bought at a strike price while the other is sold at a higher strike price. Hence the spread between the strike prices.
It’s what we would call a vertical spread if you thought about the price on the y-axis.
Your reward is reduced by using this options strategy because of the premium you would collect on the call option sale. The downside is that your profit is limited if the stock price continues to rise. However, it is a bullish strategy that requires the price to rise.
OPTIONS STRATEGY APPROVAL SHEET
When it all comes down to this, it’s best to trade options with a solid understanding of technical analysis. In this sense, the same technical patterns you see when trading stocks will most likely help your options trading strategy as well.
For example, if you expect a breakout to be imminent for a specific trading model, you could employ an options trading strategy to take advantage of the move.
These are some of the most common trend reversal chart patterns. And while we’ve given you an idea of where to get a naked call option, you could easily employ any kind of options strategy that fits your setup.
