Options Trading Strategies

If you’re not familiar with the word “Options” in the financial world, then this blog is for you. Options are derivative contracts that give the holder the right (but not the obligation) to buy or sell an underlying asset at a specified price on or before a specified date of expiry.

There are multiple ways to trade in options generally termed as trading strategies. In this blog, we will delve into the detailed study of widely used bullish, bearish, and neutral options trading strategies.

Before we delve deeper, let us understand the broader terminologies used in the options world:

Spread

A spread involves buying and selling options of the same type (either call or put) on the same underlying asset but with different strike prices or expiry dates. The main objective of spread strategies is to profit from differences in premiums. Spreads are multi-leg strategies that involve two or more trades.

Straddle

In a straddle, the investor buys both the call option as well as a put option with the same strike price and same date of expiry. Straddle is used when investors expect volatility in the market and are not sure in which direction the market will move. 

Strangle

Strangle is more or less similar to straddle but involves buying a call option and a put option with different strike prices that are slightly out of the money. Strangle is used when investors are uncertain about the direction and are expecting high volatility.

Now, let us understand the strategies in detail.

Read Also: Best Options Trading Chart Patterns

Bullish Trading Strategies

Long Call

This is a vanilla or a simple strategy where the investor buys a call option and earns profits from an increase in the price of the underlying asset. Profit potential in long calls is unlimited.

Bull Call Spread

In a Bull call spread, investors buy a call option with a lower strike price (in the money or at the money) and sell a call option with a higher strike price (out of the money). Both the trades are of the same expiry.

Investors pay a net premium to enter into the trade. The premium paid for the call bought is partially offset by the premium received from selling the call with a higher strike price.

The maximum profit is limited and happens when the price of the underlying asset is at or above the higher strike price on the expiry date.

Bull Put Spread

In a bull put spread investors are moderately bullish on underlying assets. The investor sells a put option (at-the-money) with a higher strike price and simultaneously buys a put option (out-of-the-money) with a lower strike price on the underlying asset.

Traders receive a net premium when establishing the spread and the maximum profit is limited to the net premium received when establishing the spread and happens when the price of the underlying asset is at or above the higher strike price at the date of expiry.

Call Ratio Back Spread

Call ratio back spread is a strategy used by investors when they expect a rise in the price of the underlying asset. The investor sells a specific number of call options that are at-the-money or in-the-money. Simultaneously, the investor buys a larger quantity of call options with a higher strike price and these call options are out-of-the-money.

Maximum profit in the call ratio back spread strategy is unlimited if the price of the underlying asset rises substantially.

Protective Put Strategy

This strategy is designed to protect the investor’s existing position of the stock from downside risk. In this strategy, the investor already owns the underlying stock and he buys a put option with a strike price equal to or close to the current market price. The investor pays a premium to buy the put options and these put options act as insurance.

Maximum profit potential in the protective put strategy is unlimited as stock can move upside infinitely.

If an investor buys the stock and put at the same time, it is known as “Married Put”.

Bearish Trading Strategies

Bear Call Spread

Bear Call spread is a bearish trading strategy that involves selling a call option with a lower strike price and simultaneously buying another call option with the same expiry date but at a higher strike price. Risk and reward in a bear call spread are limited.

Bear Put Spread

An investor chooses this strategy if he expects the price of an underlying asset will go down in the future, however, not significantly.

In a bear put spread, an investor buys a put option with a higher strike price that gives him the right to sell the underlying asset before or at the date of expiry and simultaneously the investor sells a put option with a lower strike price that gives him an obligation to buy the underlying asset. Maximum profit is limited to the difference between strike prices minus net premium paid. Maximum loss is limited to the net premium paid.  

Neutral Trading Strategies

Covered Call Writing

In this strategy, the investor already owns a stock. The investor sells the call option against the owned stock and receives a premium upfront for selling the call option and this premium is the maximum profit.

Now, if the stock price rises above the strike price of the call option by the expiry date, the buyer will exercise the option and the investor will have to sell the shares at the strike price and will keep the initial price of the stock and the premium. The profit potential is limited to the strike price.

If the stock price stays below the strike price by the expiry date, the option will expire worthless and the investor will pocket the gains, i.e., the premium received.  

Iron Condor options strategy

The iron condor options strategy combines two spreads: bull put spread and bear call spread so that profits can be generated even from the low volatility of the price movement of the underlying asset. In this strategy, the investor sells a put option with a higher strike price and buys a put option with a lower strike price thus creating a credit spread.

Simultaneously, he sells a call option with a higher strike price and buys a call option with a lower strike price. This creates another credit spread.

Both the call and put options have the same date of expiry. The profit potential is limited to the net premium received.

Butterfly Spread Options Strategies

A butterfly spread option strategy uses multiple option contracts to create a position with limited risk and limited profit potential.

There are two main types of butterfly spreads

• Long Call Butterfly Spread – In a long butterfly spread, the investor buys one lower strike call option, sells two middle strike call options and buys one higher price call option. Profit and loss potential in this strategy is limited.
• Short Call Butterfly Spread – In a short call butterfly spread the investor sells one lower strike price call option, buys two middle strike price call options, and sells one higher strike price call option. Profit and loss potential in this strategy is limited.

Read Also: Trading For Beginners: 5 Things Every Trader Should Know

Conclusion

We have explored various option trading strategies, each having a unique style and payoff. Choose an option strategy after analysing the market trend and that aligns with your risk profile. Understand the chosen strategy before implementation and do not forget to adjust your market strategies according to the prevailing market conditions. Regularly monitor your positions to mitigate losses because options trading carries inherent risk. It is advised to consult a financial advisor before trading.

S.NO.	Check Out These Interesting Posts You Might Enjoy!
1	Short Straddle: Option Strategy with Examples
2	Top Algorithmic Trading Strategies
3	What is Zero Days to Expiration (0DTE) Options and How Do They Work?
4	Types of Traders in the Stock Market: Styles, Strategies & Pros and Cons
5	Risk Management In Trading: Meaning, Uses, and Strategies