Most popular option trading strategy

Top 4 options strategies for beginners.

Options are excellent tools for both position trading and risk management, but finding the right strategy is key to using these tools to your advantage. Beginners have several options when choosing a strategy, but first you should understand what options are and how they work.

Picking the proper options strategy to use depends on your market opinion and what your goal is.

In a covered call (also called a buy-write), you hold a long position in an underlying asset and sell a call against that underlying asset. Your market opinion would be neutral to bullish on the underlying asset. On the risk vs. reward front, your maximum profit is limited and your maximum loss is substantial. If volatility increases, it has a negative effect, and if it decreases, it has a positive effect.

10 Options Strategies to Know.

10 Options Strategies To Know.

Too often, traders jump into the options game with little or no understanding of how many options strategies are available to limit their risk and maximize return. With a little bit of effort, however, traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction.

10 Options Strategies To Know.

Too often, traders jump into the options game with little or no understanding of how many options strategies are available to limit their risk and maximize return. With a little bit of effort, however, traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction.

1. Covered Call.

Aside from purchasing a naked call option, you can also engage in a basic covered call or buy-write strategy. In this strategy, you would purchase the assets outright, and simultaneously write (or sell) a call option on those same assets. Your volume of assets owned should be equivalent to the number of assets underlying the call option. Investors will often use this position when they have a short-term position and a neutral opinion on the assets, and are looking to generate additional profits (through receipt of the call premium), or protect against a potential decline in the underlying asset's value. (For more insight, read Covered Call Strategies For A Falling Market.)

2. Married Put.

In a married put strategy, an investor who purchases (or currently owns) a particular asset (such as shares), simultaneously purchases a put option for an equivalent number of shares. Investors will use this strategy when they are bullish on the asset's price and wish to protect themselves against potential short-term losses. This strategy essentially functions like an insurance policy, and establishes a floor should the asset's price plunge dramatically. (For more on using this strategy, see Married Puts: A Protective Relationship . )

3. Bull Call Spread.

In a bull call spread strategy, an investor will simultaneously buy call options at a specific strike price and sell the same number of calls at a higher strike price. Both call options will have the same expiration month and underlying asset. This type of vertical spread strategy is often used when an investor is bullish and expects a moderate rise in the price of the underlying asset. (To learn more, read Vertical Bull and Bear Credit Spreads.)

4. Bear Put Spread.

The bear put spread strategy is another form of vertical spread​ like the bull call spread. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price. Both options would be for the same underlying asset and have the same expiration date. This method is used when the trader is bearish and expects the underlying asset's price to decline. It offers both limited gains and limited losses. (For more on this strategy, read Bear Put Spreads: A Roaring Alternative To Short Selling.)

Investopedia Academy "Options for Beginners"

Now that you've learned a few different options strategies, if you're ready to take the next step and learn to:

Improve flexibility in your portfolio by adding options Approach Calls as down-payments, and Puts as insurance Interpret expiration dates, and distinguish intrinsic value from time value Calculate breakevens and risk management Explore advanced concepts such as spreads, straddles, and strangles.

5. Protective Collar.

A protective collar strategy is performed by purchasing an out-of-the-money put option and writing an out-of-the-money call option at the same time, for the same underlying asset (such as shares). This strategy is often used by investors after a long position in a stock has experienced substantial gains. In this way, investors can lock in profits without selling their shares. (For more on these types of strategies, see Don't Forget Your Protective Collar and How a Protective Collar Works.)

6. Long Straddle.

A long straddle options strategy is when an investor purchases both a call and put option with the same strike price, underlying asset and expiration date simultaneously. An investor will often use this strategy when he or she believes the price of the underlying asset will move significantly, but is unsure of which direction the move will take. This strategy allows the investor to maintain unlimited gains, while the loss is limited to the cost of both options contracts. (For more, read Straddle Strategy A Simple Approach To Market Neutral . )

7. Long Strangle.

In a long strangle options strategy, the investor purchases a call and put option with the same maturity and underlying asset, but with different strike prices. The put strike price will typically be below the strike price of the call option, and both options will be out of the money. An investor who uses this strategy believes the underlying asset's price will experience a large movement, but is unsure of which direction the move will take. Losses are limited to the costs of both options; strangles will typically be less expensive than straddles because the options are purchased out of the money. (For more, see Get A Strong Hold On Profit With Strangles.)

8. Butterfly Spread.

All the strategies up to this point have required a combination of two different positions or contracts. In a butterfly spread options strategy, an investor will combine both a bull spread strategy and a bear spread strategy, and use three different strike prices. For example, one type of butterfly spread involves purchasing one call (put) option at the lowest (highest) strike price, while selling two call (put) options at a higher (lower) strike price, and then one last call (put) option at an even higher (lower) strike price. (For more on this strategy, read Setting Profit Traps With Butterfly Spreads . )

9. Iron Condor.

An even more interesting strategy is the iron condor. In this strategy, the investor simultaneously holds a long and short position in two different strangle strategies. The iron condor is a fairly complex strategy that definitely requires time to learn, and practice to master. (We recommend reading more about this strategy in Take Flight With An Iron Condor, Should You Flock To Iron Condors? and try the strategy for yourself (risk-free!) using the Investopedia Simulator.)

10. Iron Butterfly.

The final options strategy we will demonstrate here is the iron butterfly. In this strategy, an investor will combine either a long or short straddle with the simultaneous purchase or sale of a strangle. Although similar to a butterfly spread, this strategy differs because it uses both calls and puts, as opposed to one or the other. Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors will often use out-of-the-money options in an effort to cut costs while limiting risk. (To learn more, read What is an Iron Butterfly Option Strategy?)

Options Trading Strategies.

How to Trade Options.

By Beth Gaston Moon, InvestorPlace Contributor.

Options Trading Strategies: Buying Call Options.

Buying a call option —or making a “long call” trade— is a simple and straightforward strategy for taking advantage of an upside move or trend. It is also probably the most basic and most popular of all option strategies. Once you purchase a call option (also called “establishing a long position”), you can:

• Exercise your right to buy the stock at the strike price on or before expiration.

A call option gives you the right, but not the obligation, to buy the stock (or “call” it away from its owner) at the option’s strike price for a set period of time (until your options will expire and are no longer valid).

Typically, the main reason for buying a call option is because you believe the underlying stock will appreciate before expiration to more than the strike price plus the premium you paid for the option. The goal is to be able to turn around and sell the call at a higher price than what you paid for it.

The maximum amount you can lose with a long call is the initial cost of the trade (the premium paid), plus commissions, but the upside potential is unlimited. However, because options are a wasting asset, time will work against you. So be sure to give yourself enough time to be right.

Options Trading Strategies: Buying Put Options.

Investors occasionally want to capture profits on the down side, and buying put options is a great way to do so. This strategy allows you to capture profits from a down move the same way you capture money on calls from an up move. Many people also use this strategy for hedges on stocks they already own if they expect some short-term downside in the shares.

When you purchase a put option, it gives you the right (but, not the obligation) to sell (or “put” to someone else) a stock at the specified price for a set time period (when your options will expire and no longer be valid).

For many traders, buying puts on stocks they believe are headed lower can carry less risk than shorting the stock and can also provide greater liquidity and leverage. Many stocks that are expected to decline are heavily shorted. Because of this, it’s difficult to borrow the shares (especially on a short-them basis).

On the other hand, buying a put is generally easier and doesn’t require you to borrow anything. If the stock moves against you and heads higher, your loss is limited to the premium paid if you buy a put. If you’re short the stock, your loss is potentially unlimited as the stock rallies. Gains for a put option are theoretically unlimited down to the zero mark if the underlying stock loses ground.

Options Trading Strategies: Covered Calls.

Covered calls are often one of the first option strategies an investor will try when first getting started with options. Typically, investor will already own shares of the underlying stock and will sell an out-of-the-money call to collect premium. The investor collects a premium for selling the call and is protected (or “covered”) in case the option is called away because the shares are available to be delivered if needed, without an additional cash outlay.

One main reason investors employ this strategy is to generate additional income on the position with the hope that the option expires worthless (i. e., does not become in-the-money by expiration). In this scenario, the investor keeps both the credit collected and the shares of the underlying. Another reason is to “lock in” some existing gains.

The maximum potential gain for a covered call is the difference between the purchased stock price and the call strike price plus any credit collected for selling the call. The best-case scenario for a covered call is for the stock to finish right at the sold call strike. The maximum loss, should the stock experience a plunge all the way to zero, is the purchase price of the strike minus the call premium collected. Of course, if an investor saw his stock spiraling toward zero, he would probably opt to close the position long before this time.

Options Trading Strategies: Cash-Secured Puts.

A cash-secured put strategy consists of a sold put option, typically one that is out-of-the-money (that is, the strike price is below the current stock price). The “cash-secured” part is a safety net for the investor and his broker, as enough cash is kept on hand to buy the shares in case of assignment.

Investors will often sell puts and secure them with cash when they have a moderately bullish outlook on a stock. Rather than buy the stock outright, they sell the put and collect a small premium while “waiting” for that stock to decline to a more palatable buy-in point.

If we exclude the possibility of acquiring the stock, the maximum profit is the premium collected for selling the put. The maximum loss is unlimited down to zero (which is why many brokers make you earmark cash for the purpose of buying the stock if it’s “put” to you). Breakeven for a short put strategy is the strike price of the sold put less the premium paid.

Options Trading Strategies: Credit Spreads.

Option spreads are another way relatively novice options traders can begin to explore this new family of derivatives. The most basic credit and debit spreads combine two puts or calls to yield a net credit (or debit) and create a strategy that offers both limited reward and limited risk. There are four types of basic spreads: credit spreads (bear call spreads and bull put spreads) and debit spreads (bull call spreads and bear put spreads). As their names imply, credit spreads are opened when the trader sells a spread and collects a credit; debit spreads are created when an investor buys a spread, paying a debit to do so.

In all of the types of spreads below, the options purchased/sold are on the same underlying security and in the same expiration month.

Bear Call Spreads.

A bear call spread consists of one sold call and a further-from-the-money call that is purchased. Because the sold call is more expensive than the purchased, the trader collects an initial premium when the trade is executed and then hopes to keep some (if not all) of this credit when the options expire. A bear call spread may also be referred to as a short call spread or a vertical call credit spread.

The risk/reward profile of the strategy can vary depending on the “moneyness” of the options selected (whether they are already out-of-the-money when the trade is executed or in-the-money, requiring a sharper downside move in the underlying). Out-of-the-money options will naturally be cheaper, and therefore the initial credit collected will be smaller. Traders accept this smaller premium in exchange for lower risk, as out-of-the-money options are more likely to expire worthless.

Maximum loss, should the underlying stock be trading above the long call strike, is the difference in strike prices less the premium paid. For example, if a trader sells a $32.50 call and buys a $35 call, collecting a credit of 90 cents, the maximum loss on a move above $35 is $1.60. The maximum potential profit is limited to the credit collected if the stock is trading below the short call strike at expiration. Breakeven is the strike of the purchased put plus the net credit collected (in the above example, $35.90).

Bull Put Spreads.

These are a moderately bullish to neutral strategy for which the seller collects premium, a credit, when opening the trade. Typically speaking, and depending on whether the spread traded is in-, at-, or out-of-the-money, a bull put spread seller wants the stock to hold its current level (or advance modestly). Because a credit is collected at the time of the trade’s inception, the ideal scenario is for both puts to expire worthless. For this to happen, the stock must be trading above the higher strike price at expiration.

Unlike a more aggressive bullish play (such as a long call), gains are limited to the credit collected. But risk is also capped at a set amount, no matter what happens to the underlying stock. Maximum loss is just the difference in strike prices less the initial credit. Breakeven is the higher strike price less this credit.

While traders are not going to collect 300% returns through credit spreads, they can be one way for traders to steadily collect modest credits. This is especially true when volatility levels are high and options can be sold for a reasonable premium.

Options Trading Strategies: Debit Spreads.

Bull Call Spreads.

The bull call spread is a moderately bullish strategy for investors projecting modest upside (or at least no downside) in the underlying stock, ETF or index. The two-legged vertical spread combines the same number of long (purchased) closer-to-the-money calls and short (sold) farther-from-the-money calls. The investor pays a debit to open this type of spread.

The strategy is more conservative than a straight long call purchase, as the sold higher-strike call helps offset both the cost and the risk of the purchased lower-strike call.

A bull call spread’s maximum risk is simply the debit paid at the time of the trade (plus commissions). The maximum loss is endured if the shares are trading below the long call strike, at which point, both options expire worthless. Maximum potential profit for a bull call spread is the difference between strike prices less the debit paid. Breakeven is the long strike plus the debit paid. Above this level, the spread begins to earn money.

Bear Put Spreads.

Investors employ this options strategy by buying one put and simultaneously selling another lower-strike put, paying a debit for the transaction. An investor might use this strategy if he expects moderate downside in the underlying stock but wants to offset the cost of a long put.

Maximum loss — suffered if the underlying stock is trading above the long put strike at expiration — is limited to the debit paid. The maximum potential profit is capped at the difference between the sold and purchased strike prices less this premium (and is achieved if the underlying is trading south of the short put). Breakeven is the strike of the purchased put minus the net debit paid.

Okay, now you’ve learned the basics and may be itching to try your hand at virtual options trading. It’s time to select a broker if you don’t already have one.

Article printed from InvestorPlace Media, investorplace/2012/04/options-trading-strategies/.

©2017 InvestorPlace Media, LLC.

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4 Common Active Trading Strategies.

Active trading is the act of buying and selling securities based on short-term movements to profit from the price movements on a short-term stock chart. The mentality associated with an active trading strategy differs from the long-term, buy-and-hold strategy. The buy-and-hold strategy employs a mentality that suggests that price movements over the long term will outweigh the price movements in the short term and, as such, short-term movements should be ignored. Active traders, on the other hand, believe that short-term movements and capturing the market trend are where the profits are made. There are various methods used to accomplish an active-trading strategy, each with appropriate market environments and risks inherent in the strategy. Here are four of the most common types of active trading and the built-in costs of each strategy. (Active trading is a popular strategy for those trying to beat the market average. To learn more, check out How To Outperform The Market .)

Day trading is perhaps the most well known active-trading style. It's often considered a pseudonym for active trading itself. Day trading, as its name implies, is the method of buying and selling securities within the same day. Positions are closed out within the same day they are taken, and no position is held overnight. Traditionally, day trading is done by professional traders, such as specialists or market makers. However, electronic trading has opened up this practice to novice traders. (For related reading, also see Day Trading Strategies For Beginners .)

[ Learning which strategy is going to work best for you is one of the first steps you need to take as an aspiring trader . If you're interested in day trading, Investopedia Academy's Day Trader Course can teach you a proven strategy that includes six different types of trades. ]

Some actually consider position trading to be a buy-and-hold strategy and not active trading. However, position trading, when done by an advanced trader, can be a form of active trading. Position trading uses longer term charts - anywhere from daily to monthly - in combination with other methods to determine the trend of the current market direction. This type of trade may last for several days to several weeks and sometimes longer, depending on the trend. Trend traders look for successive higher highs or lower highs to determine the trend of a security. By jumping on and riding the "wave," trend traders aim to benefit from both the up and downside of market movements. Trend traders look to determine the direction of the market, but they do not try to forecast any price levels. Typically, trend traders jump on the trend after it has established itself, and when the trend breaks, they usually exit the position. This means that in periods of high market volatility, trend trading is more difficult and its positions are generally reduced.

When a trend breaks, swing traders typically get in the game. At the end of a trend, there is usually some price volatility as the new trend tries to establish itself. Swing traders buy or sell as that price volatility sets in. Swing trades are usually held for more than a day but for a shorter time than trend trades. Swing traders often create a set of trading rules based on technical or fundamental analysis; these trading rules or algorithms are designed to identify when to buy and sell a security. While a swing-trading algorithm does not have to be exact and predict the peak or valley of a price move, it does need a market that moves in one direction or another. A range-bound or sideways market is a risk for swing traders. (For more on swing trading, see our Introduction To Swing Trading .)

Scalping is one of the quickest strategies employed by active traders. It includes exploiting various price gaps caused by bid/ask spreads and order flows. The strategy generally works by making the spread or buying at the bid price and selling at the ask price to receive the difference between the two price points. Scalpers attempt to hold their positions for a short period, thus decreasing the risk associated with the strategy. Additionally, a scalper does not try to exploit large moves or move high volumes; rather, they try to take advantage of small moves that occur frequently and move smaller volumes more often. Since the level of profits per trade is small, scalpers look for more liquid markets to increase the frequency of their trades. And unlike swing traders, scalpers like quiet markets that aren't prone to sudden price movements so they can potentially make the spread repeatedly on the same bid/ask prices. (To learn more on this active trading strategy, read Scalping: Small Quick Profits Can Add Up . )

Costs Inherent with Trading Strategies.

There's a reason active trading strategies were once only employed by professional traders. Not only does having an in-house brokerage house reduce the costs associated with high-frequency trading, but it also ensures a better trade execution. Lower commissions and better execution are two elements that improve the profit potential of the strategies. Significant hardware and software purchases are required to successfully implement these strategies in addition to real-time market data. These costs make successfully implementing and profiting from active trading somewhat prohibitive for the individual trader, although not all together unachievable.

Active traders can employ one or many of the aforementioned strategies. However, before deciding on engaging in these strategies, the risks and costs associated with each one need to be explored and considered. (For related reading, also take a look at Risk Management Techniques For Active Traders .)