Published : November 7, 2020
Options give the investors the ability to configure his investment goals in the way he wishes. We are going to explain four basic but important option trading strategies that could be considered good for a novice options trader as these are simple to implement. There are certain terms in options trading, which you have to understand first before going into the trading part of it.
Strike Price: A strike price is a pre-defined price at which a contract could be traded when it is exercised.
Expiry: An option contract is only valid till a certain date, which is called expiry.
At the money (ATM): When the price of the underlying is at the strike price that is called at the money option.
Out of the money (OTM): when the strike price is far from the underlying, it is called out of the money (OTM) for a call option, whereas for a put option, the strike price is below the underlying price.
In the Money (ITM): When the strike price is below the price of the underlying for a call option, it is called ITM, and for a put option, the price is far from the underlying.
Long Call: The most basic options trading strategies are to buy a naked call because it is easy to understand. Long call or buying a call means the buyer has the option to buy the underlying, which means that when the underlying will go up, the buyer will make a profit. Traders need to have an uptrend to use this strategy as a profitable one. As you are paying a premium to buy the option, so it is a net debit transaction where the maximum risk is to the price you have paid for the option to buy, whereas your maximum reward is unlimited. Time decay works against you, so it advised in this strategy to close your position before expiry. The ideal time period for this strategy is more than three or more months to expire.
Long Put: The long put strategy in option trading works in a similar way as the long call strategy, while the long put strategy is traded when the underlying is expected to fall. This is also a net debit position as you have to pay a premium in order to be in the trade. The maximum risk is also similar to the previous strategy so that the maximum risk would be of the premium paid by you, and the maximum profit is unlimited. Time decay works against you in this strategy, so it is advised to close the strategy before expiry as the time decay is maximum near expiry. Traders are advised to use this strategy when you have more time to expire, like three or more months.
Bull Call Spread: The bull call spread is a very popular option trading strategy among all the spread strategies, and this strategy is used when you have a moderately bullish view on the underlying. This strategy involves two legs and the pair form in one in the money call (ITM) and one out of the money (OTM) call.
The implementation of this strategy involves selling one OTM call and buying one ITM call. You have to ensure before entering the trade that both the strikes belong to the same underlying. The expiry series also has to be the same, and both the legs have to have the same number of options.
Bear Put Spread: Bear put spread is quite similar to the previous strategy bull call spread. You are advised to use this strategy when the market outlook is slightly bearish; however, at the same time, you don’t expect the market to go too much down. This strategy involves buying one in the money (ITM) put option and selling one out of the money (OTM) put option. This spread is a net debit spread where you have to pay the premium while opening into the trades. The strike has to be of the same underlying, and the expiry series also has to be the same, and both the legs have to have the same number of options.
We have explained basic strategies for trading options from the point of view of simplicity and risk. In all of the four strategies, the risk is limited while their profit window is uncapped. However, the most needed thing to keep in mind for these strategies is to view the trend.
March 5, 2023 5:06 am
Thank you for another great article. Where else could anybody get that kind of information in such an ideal way of writing? I have a presentation next week, and I’m on the look for such info.
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