Options are among the most popular trading vehicles because their prices can fluctuate rapidly, allowing speculators to make (or lose) a great deal of money rapidly. Strategies involving options can range from quite simple to extremely complex, with a variety of payoffs and occasionally strange names. (Anyone for Iron Condor?)
Call and put options are the foundation of all option strategies, regardless of their complexity.
Below are five prominent options trading strategies, along with a breakdown of their reward and risk, as well as examples of when a trader might use them for their next investment. Although these strategies are relatively simple, they can make a trader a great deal of money, but they are not risk-free. Before we begin, here are some guides on the fundamentals of call options and put options.
Long phone call
In this option trading strategy, the trader purchases a call, also known as “going long” on a call, with the expectation that the stock price will surpass the strike price by expiration. If the stock rises, traders can earn multiple times their initial investment if they execute this trade.
Example: A call option with a strike price of $20 and an expiration date of four months trades for $1. The cost of the contract is $100, or one contract * $1 * 100 shares per contract.
Covered call
A covered call entails selling a call option with a twist (“going short”). Here, the trader sells a call but also purchases 100 shares of the underlying stock for each call sold. Stock ownership transforms a potentially risky trade, the short call, into a comparatively safe trade that can generate income. At expiration, traders anticipate the stock price to be below the strike price. If the stock concludes above the strike price, the owner must sell the stock at the strike price to the call buyer.
Example: A call option with a strike price of $20 and an expiration date of four months trades for $1. The contract pays a $100 premium, or one contract * $1 * 100 shares per contract. The investor purchases 100 shares of stock for $2,000 and sells one call for $100.
Long put
In this strategy, the trader purchases a put, also known as “going long” on a put, with the expectation that the stock price will be below the strike price at expiration. If the stock declines substantially, the potential return on this trade could be many times the initial investment.
Example: A put option with a strike price of $20 and an expiration date of four months is trading for $1. The cost of the contract is $100, or one contract * $1 * 100 shares per contract.
Short-put
This options trading strategy is the inverse of the long put, in which the trader sells a put (also known as “going short” on a put) and anticipates that The stock price will be greater than the strike price at expiration. The trader receives a cash premium in exchange for selling a put, which is the maximum return a short put can generate. If the stock closes at expiration below the strike price, the trader must purchase the stock at the strike price.
Example: A put option with a strike price of $20 and an expiration date of four months is trading for $1. The contract pays a $100 premium, or one contract * $1 * 100 shares per contract.
married put
This strategy is a variation on the long put. The trader possesses the underlying security and purchases a put option. This is a hedged trade in which the trader anticipates the stock will rise but desires “insurance” in case the stock declines. If the stock falls, the long put will counterbalance the loss.
Example: A put option with a strike price of $20 and an expiration date of four months is trading for $1. The cost of the contract is $100, or one contract * $1 * 100 shares per contract. The investor purchases 100 shares of stock for $2,000 and one put option for $100.
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