There are a wide variety of strategies exist for options trading. Options are one of the most adaptable investment tools, thus, many new option traders usually only focus on making money. Yet, if you one of those new option traders, you may want to consider these few option trading strategies.
Before you start
One most important note for a new trader is to never put money at risk unless you really understand what you are doing. Always make sure that the trade matches your risk tolerance. If, at some point, you do not understand what should happen in a position to make money, then do not make a trade.
It is impossible for you to accomplish anything in options trading without a firm understanding of the strategies.
The recommended strategies
The four most recommended and popular option trading strategies are covered call writing, cash-secured sale of naked puts, credit, and debit spread.
Covered calls
Covered calls involve stock ownership. To implement this strategy, you need to buy 100 shares (or in multiples of 100). Or else, you can use the shares you have owned, and sell one call option for every 100 shares.
Once you write a covered call, then there is only two possible outcomes:
- If it is exercised, the stock sold at the agreed price. That way you gain profit and have to keep the cash premium.
- If it is expired, you still own the stock and can write another call option, but you lose your premium.
Naked puts
If you sell when the stock price is higher than the strike price, then the cash premium is collected. That cash, in all of the possible conditions, is yours. There are two possible outcomes here:
- It expires, your profit is only the cash premium collected.
- The expiration arrives, when the stock price is lower than the strike price. Then, the owner can use its rights to sell 100 shares of stocks at the strike price. At the same time, you have the obligation to buy the shares.
Credit Spreads
Different from selling unprotected naked-options, credit spreads allow the trader to sell one put and buy another. The put you purchased work as the insurance policy. It limits the loss.
Yet, it also reduces the possible profit. But remember, limiting the loss should always become your first priority.
This is the most effective strategy for most of the option traders. However, novice options traders should have a sufficient understanding of the basics of trading individual option, before they use credit spreads.
