Last updated on October 7, 2020
There are two major requirements when it comes to options trading- an excellent money management system and the best options trading strategy. Although options family (currencies, indices, stocks, and commodities) have exclusive peculiarities, there are some unique strategies that work for all of them. It’s also important for investors to use successful and tested trading strategies for generating better results in quickly moving markets. Analysts and investors recommend using strategies that increase profit potential and lower the risk. Below are few tested and proven strategies that analysts recommend to expand options trading portfolios and average returns.
There are two types of options – call and put. When the investor purchases the right to buy the asset in the future at a strike price is called a call option, while when an investor buys the position to sell the asset in the future at the strike price is called a put option.
Buying long put
This type of option strategy is suggested to investors who are bearish on any stock or commodity and the investor doesn’t want to risk his money in a short sell strategy. This strategy is also significant for investors who want to take benefit of a leveraged position. For instance, if the investor is bearish on Apple (NASDAQ: AAPL) and he believes the price of Apple will fall steadily in the coming days. However, the investor doesn’t want to risk the money on short-term movements and sets the longer expiry time.
Although a put option enables investors to increase returns if the stock price falls, the long put option also lets the investors losing only the premium amount if the stock price increases.
Buying long call
This strategy is recommended for those investors who are significantly bullish on the long-term fundamentals of the particular asset and these investors don’t want to take a higher risk in the case of downside movement. This type of option trading strategy is also vital for investors who are planning to take leveraged profit from bearish market conditions.
Those investors who anticipate the stock price to remain range-bound are suggested to use covered call options trading strategy. This trading strategy is also vital for investors who look to limit downside potential with the limited upside potential protection. This strategy is also useful for investors who are looking to make a long position or a short position in a call option.
For example, investors believe that General Electric (NYSE: GE) shares have strong future fundamentals, but the investor also expects its share price to remain range-bound in the short-term. If the investors sell a call option on General Electric, the investors will not only get the premium after selling a call option but also caps upside.
This type of options trading strategy is suggested to investors who have a position in an asset and looking for downside protection. The protective put strategy works for investors who hold a long position in an asset along with a long put option position. This strategy means that if the price of an asset increases at maturity, the investors will only lose the premium and the option expires worthless, as the investor is likely to get the benefit of the higher price. Similarly, if the asset price declines, the options investor’s portfolio position will drop value, but his put option position will help him in covering losses.
Vertical Debit Spread: Calls
This options trading strategy lets investors pursuing bigger profits at a lower risk. This strategy has truly significant importance for investors who are trading cyclical assets or trading assets during the volatile periods. Vertical debit spread calls options strategy helps investors in making profits when they expect sharp movement in the price of the asset. This strategy only works when the investor buys and sells a call option on a similar asset at the same time.
The call an investor buys is more expensive and has a lesser strike price, but this option requires a smaller movement in the asset to become worthy. On the other hand, the call an investor will sell has a bigger strike price but is not as much value. The main theme is the amount an investor receives by selling a call option can facilitate to offset the call investor purchase. This strategy helps in making big profits if an investor made a correct guess and the asset price moves significantly higher. If investors proved wrong in his guessing ability, the investor’s loss is restricted to the net debit from these two calls.
Vertical Debit Spread: Puts
This strategy is the opposite of the vertical debit spread call strategy. This strategy involves buying a put option with a higher strike price compared to the put option an investor is going to sell. Thus, this strategy requires less of a downside move in order to make money.
This option trading strategy involves a sold put option, usually the out-of-the-money. Investors buy a put option when the stock is declining, but they have kept sufficient cash on hand to purchase the asset if the stock started rising after hitting the lowest level.
Based on this strategy, investors should sell the put option and get the small amount of premium when the stock is declining, while waiting for the asset price to decline to the lowest level to make a better entry point. According to this strategy, the breakeven point for the short put strategy is the strike price of the sold put minus the premium paid.
There are several best options trading strategies available for investors to generate bigger gains by trading securities. These strategies involve various amalgamations of options. However, the seven best options strategies for investors include buying the put, buying the call, protective put, covered call, vertical debit spreads, and cash-secured puts. These strategies are well tested and investors had made significant gains by using these options trading strategies. Therefore, sticking to these basic strategies could reduce the risk and increase the overall returns