Top 4 Options Trading Strategies Every Trader Should Know

By February 27, 2015 Newsletter No Comments

Using the right investing strategies at the right time is the key to achieving success in the realm of investing. You need to utilize effective investing methods through designing and back testing all your strategies to assess their overall impact and use the information to formulate better strategies for the future.

So if you are a beginner seeking educational material on the most effective options trading strategies, you’ve found the perfect trading partner to help you gain crucial investing and trading knowledge along with experience as you implement these strategies. In this blog post, we will walk you through the top four options trading strategies.

options trading strategies

Market View / Sentiment

The financial markets are driven by demand and supply. The basic economic concept is detrimental to understanding market behavior. Individual involved in the financial markets are responsible for the demand and supply. For example, if an increased number of people take long positions, the demand would increase and the price would increase. Therefore, it’s important to understand individual stances and overall market sentiment. Bullish, bearish, and neutral sentiments are one of the main driving factors of the market price. Hence, all strategies conform to one of the sentiments mentioned above.

  •    Covered Call

Many traders employ the covered call strategy in the hope to further increase their chances of achieving a profitable trade. The strategy requires you to purchase an asset and simultaneously write a call option in the same asset. This way, you are effectively hedging your risk in the case that the asset loses its value. The volume of the trade should be equivalent in both cases for it to be effective. The strategy is neutral is nature as the trader is uncertain about the future of the asset’s price. In the case that the price decreases, the trader is insured by the option he purchased. However, if the price increases, the trader can simply discard the option along with the premium. In this case, the profit absorbs the premium.

  •    Bull Call Spread

A bull call spread strategy can be employed when the trader is certain about an expected increase in an asset’s value. The trader will simultaneously purchase call options at predetermined strike prices and sell the same number of calls at an expected increased price. For this strategy to be effective, all contracts need to have the same expiration month. These types of strategies are generally referred to as vertical spread strategies because orders have been placed as the price increases. The amount of profit earned is determined by measuring the difference between the premiums of the two options contracts.

  •      Bear Put Spread

The bear put spread is essentially the same thing as the bull call spread, the difference being that instead of the orders being vertically spread upwards, they are spread downwards. The strategy can be utilized when the trader has a bearish outlook on the asset’s market price. The trader will simultaneously purchase put options at predetermined strike prices and then sell the same number of options at a lower price. The strategy requires that both options purchased and sold are the same assets with a similar expiration month. The amount of profit will be the difference between the premiums of the two or more options contracts.

Both bear put spread and bull call spread involve a relatively small amount of risk. Therefore, the gains or losses are also limited.

  •     Protective Collar

As the name suggests, protective collar is a defensive strategy, which will effectively protect you against potentially huge losses but the decreased risk will also prevent you from achieving massive gains. To perform a protective collar strategy, the trader will need to perform an out-of-the-money put option as well as a call option. Out of the money put or call is any order which is either lower or higher than the market price, respectively.

This strategy is mostly used once a trader or investor has already achieved a high degree of profit on a trade but doesn’t wish to sell the asset just yet. Using options contracts, the trader can perform a protective collar strategy, which will effectively insure the gains, which are already made but not realized. This will protect a long position from losing value in the case that the market retraces the gains. If the price does fall, the difference will be absorbed by the out-of-money call.

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