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Learning options from all angles gives you access to a wide variety of investment strategies. Some are considered speculative; others are considered safer, but it all depends on who you ask. Speculation is often equated with a low win rate while safety is usually associated with high win-rate strategies. Depending on your investment personality, this may be the best way to think about things.
Before we get into options strategies you can use, it is essential that you define success for yourself. Doing this will help you match your investment strategy to your personality, clearing many of the hurdles that beginners face.
Once you define success, choosing your strategies becomes easier to do.
Best Options Strategies to Know
Here are some of the most effective options trading strategies you can use in the right situation as a profit booster. Strategies will be matched with trading profiles to give you context as to who might enjoy using them.
Selling Covered Calls
Selling a call means writing a contract that gives a buyer the right to purchase 100 shares of stock from you at the contract strike price. Because you are selling, you are taking in an immediate premium from the buyer, known as the time and intrinsic value of the option.
When you sell covered calls, you are only writing contracts on shares you own. For example, if you own 300 shares, you could write 3 covered calls.
Selling a covered call out of the money means that you write the contract at a strike price that is higher than the current price of the stock. If the contract expires out of the money, it is worthless and will not be exercised. You will keep the premium and the shares of stock you own.
Options Strategy for Risk-Averse Traders: Buying LEAPS
The long-term equity anticipation security (LEAPS) is a great way to earmark a stock for purchase without committing the full purchase price. LEAPS are also an excellent way to put a stock on layaway if you do not have the money to purchase as much of it as you want.
LEAPS are options with expiry cycles of longer than 1 year, with some experts defining the LEAP with a 2-year cycle. The premium you pay to control 100 shares of the stock is significantly less than buying 100 shares. Another advantage: If the contract itself becomes profitable, you can sell it without buying the shares.
Note: A trader would buy a lot of time value here for LEAPs due to the extended expiration dates compared to watching the asset market to either time their entry into the asset or purchase a shorter-term option. Although the downside is limited, that long time frame does present a risk to the initial outlay of funds for premium.
The major advantage of buying LEAPS is that your maximum loss is limited to the amount of premium you pay. Most risk-averse traders love the ability to control shares of stock without spending thousands on their purchase and the trade’s defined risk profile. This strategy works well with NASDAQ and Russell 2000 growth stocks that offer no dividend and would otherwise scare away risk-averse traders because of their wild price swings.
Options Strategy for Risk Neutral Traders: The Iron Condor
Risk neutral strategies take the stance of not knowing whether a stock will rise or fall. The profit in this class of strategies comes from changes in the underlying asset, especially at expiration. If a stock was trading in a wide range and calms down, or vice versa, options can gain or lose value with no net gain or loss in the stock price.
The short iron condor is a defined risk strategy with two “wings” — selling 1 out-of-the-money call vertical spread and 1 out-of-the-money put vertical spread. Each vertical spread wing involves selling a call/put out of the money and protecting it by buying a call/put that is more out of the money. You take in a net credit with this strategy that is also your maximum profit potential. Ideally, you want the price of the stock to stay between the short call and put strikes. All 4 options expire out of the money and are worthless, and you keep the upfront premium.
Options Strategy for Risk-Tolerant Traders: Buying Puts
When the market experiences a pullback or moves into a bear market, the movement is many times sudden and drastic. This is why many expert traders make a living playing the short side of the market. They deal with relatively low win rates on their strategy but the wins are usually quite significant.
Buying puts allows you to profit when a stock falls in price. This strategy seems simple because it is. The sophistication comes in the patience required to properly anticipate a fall or pullback, then to exit the trade before the market moves against you.
Buying puts is usually most appropriate when you determine that a stock is overpriced. Added signals may include a pullback in the industry or the total market that puts added selling pressure on weak stocks.
Options Strategy for Speculative Traders: The Synthetic Long/Short Stock
The synthetic long or short stock position uses options to copy buying or selling a stock, with a few major differences. We’ll go over the synthetic long position here. For the synthetic short position, switch the words “call” and “put.”
The Options Guide
The synthetic long involves buying a call and simultaneously selling a put. Because you are selling the put, the net cost of putting on this position is less than buying calls.
Although you may spend nothing for the position, the risk on the synthetic long is technically undefined. If the stock goes up, your call gains while your put becomes less expensive to buy back. Should your trade go the other way instead, you may very quickly begin to lose money. This strategy should only be considered if you are an advanced trader.
Pros and Cons of Options Trading
Trading options isn’t for everyone. Here are some of the pros and cons you should consider before moving into the market this way.
- The ability to make money in an up, down or sideways market
- Can hedge a standing position and protect a portfolio (generally requires more than 1 option or a basket option)
- Allows you to take some profits while deferring taxes on gains in larger positions
- Allows for speculation on larger positions while deferring payment
- May lose money faster than stocks
- Can have a high learning curve
- Don’t always track the price of the underlying stock
- Can sometimes be manipulated by individual traders or trader pools
- Trading loss can be higher than the net amount paid for the options strategy
Benzinga Options Newsletter
If you want to dig deeper into how options can be used, check out the Benzinga Options newsletter. Options strategies are best considered in real-time — the most effective strategies change based on the market you are in.
Define Success to Have Success
Before you move into any options trading strategy, you must define what success is to you. Most traders choose among having a high percentage win rate full of small, quick profits or a low percentage win rate with big, long-term winners. If you want to be a scalper, you need a fast, focused eye and a ruthless devotion to your trading rules. If you want the big wins, you need the discipline to engage a consistent strategy even if it loses multiple times in a row.
As any accomplished trader will tell you, define your exit point before you enter any trade. Support/resistance levels and trading indicators can help you with this. But more importantly than any technical indicator, your personality is on full display when you trade. Make sure that you are putting your best trading foot forward.
Is there a safe options strategy?
Covered calls are the safest options strategy. These allow you to sell a call and buy the underlying stock to reduce risks.
What are good options trading strategies?
Good options strategies include married puts, long straddles and a bear put spread.
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