This article delves into four advanced options strategies, continuing our exploration into multi-leg option strategies. We’ll begin with the basics of selling options, followed by a detailed discussion on various types of vertical spreads. We’ve primarily discussed purchasing options and paying premiums so far; now, we’ll shift our focus towards selling options and what it entails.
Selling Options and the Concept of Premiums
Purchasing a long call or put is relatively straightforward. You select the expiry and strike price, pay the premium, and voila! You now own the options and have the freedom to sell them whenever you want (ideally after a significant appreciation). But who are you buying these options from? The answer is simple – other traders just like yourself.
To sell an option, you generally need to own 100 shares of a stock. The simplest form of this is the covered call, which involves owning 100 shares of a particular stock, say stock XYZ. The shareholder can then sell or “write” a call option on the market, which can be done through all major brokers.
Understanding Covered Calls
Once the call is written and the price fluctuates as it nears expiry, two scenarios can unfold. Either the call will expire worthless, allowing the seller to profit from the buyer’s premium paid at the time of writing and selling the call, or the buyer of the call chooses to “exercise” the call and buy the shares at the pre-arranged strike price upon expiry or possibly before.
The covered call is the simplest type of option to write, but it’s essential to proceed slowly and with caution, ensuring you fully understand all the details involved.
Exploring Advanced Options Strategies
Here, we describe six popular options strategies many traders find successful. Remember, these strategies increase in complexity, and traders should never hastily dive into them without fully understanding the underlying frameworks of the trades and the market. It’s highly recommended to paper trade these strategies several times before committing actual capital to them.
Married Put
A married put is when a trader buys a stock and then purchases a put as downside protection. This strategy, similar to all hedging strategies, aims to protect against potential losses if the stock’s price falls, rather than profiting from the put itself.
Options Spreads
Options spreads are an excellent way to speculate on market outcomes using more than one option. They can reduce the price of opening a position due to the credit received for writing a call or put position, making them useful during times of high implied volatility.
Bull Call Spread
A bull call spread involves buying a call option while simultaneously writing a call option at a higher strike price. The goal is to profit if the underlying asset appreciates.
Bear Call Spread
A bear call spread involves selling a call option while also buying a call option at a higher strike price. This strategy is profitable if the underlying asset decreases in price.
Bull Put and Bear Put Spreads
These options involve puts, with the bull put spread involving selling a put option and buying a put option at a lower strike price, and the bear put spread doing the opposite.
Iron Condor and Iron Butterfly
These are advanced multi-leg strategies that are often deployed in sideways markets. Both involve purchasing four options contracts simultaneously, so commission costs should be considered.
Key Takeaways
Options trading strategies are incredibly diverse. They can range from buying a simple call option and selling it at a profit when the underlying asset appreciates to using more advanced multi-leg strategies as hedges to long positions or ways to profit in sideways markets. Understanding volatility is crucial for determining which options strategies to use. Whether your investment goals are short-term or long-term, learning new option strategies is a valuable educational pursuit for any retail trader.
Options are a powerful tool, offering ways to profit from both upward and downward market movements. They can also serve as hedges to long positions, provide income in sideways markets, and more. The influence of market volatility on options is crucial, and understanding this relationship is vital for any active trader.
However, it’s important to remember that all these strategies come with their own set of risks and complexities. Always do your research, understand the trade mechanics, and ideally, paper trade before committing actual capital. This way, you will gain familiarity with the strategies and be better prepared to navigate the dynamic world of options trading.
In the upcoming and final article in our series, we’ll delve further into advanced strategies and provide you with additional tools to enhance your trading skills. Whether you are a novice or experienced trader, expanding your knowledge about options strategies is an investment that can yield significant returns.
Remember, the ultimate goal is not just about making profitable trades, but also about becoming a more informed and confident trader. So, stay tuned for more insights, and happy trading!
