Essential Option Trading Strategies for Every Trader in Stock Market

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  • 01 Dec 2023

In options trading, investors have to decide if they want to execute the contract. So, options trading strategies play a critical role in making appropriate decisions. Therefore, having a thorough grasp of options trading methods is essential. There are several strategies to trade options. Each of these strategies has different risks and benefits associated with them. Let’s discuss the commonly used options trading strategies in this post.

Key Highlights

  • Options are financial contracts that give the right but not the obligation to buy the underlying assets at a fixed price on a future date. These assets can be stocks, bonds, ETFs, etc.

  • Options trading strategies are critical to trade options. They consider several factors like asset volatility, market trends, and various risk indicators.

  • Options trading strategies are mainly categorised into bullish, bearish, and neutral strategies.

  • Bullish strategies include bull call spread, bull put spread, synthetic long call, long straddle, long strangle, and long call butterfly.

  • The bear call spread, bear put spread, protective call, covered put, short straddle, short strangle, and short call butterfly are bearish strategies.

  • Examples of neutral options trading strategies are long call, short call, long put, short put, covered call, and collar.

Strategy 1: Bull Call Spread Strategy

Here, you can buy ‘in the money' call option and sell in the ‘out of the money' option. However, both options must have the same expiration date.

Strategy 2: Bull Put Spread Strategy

Here, you can protect the downside of the put by buying another put (at a lower strike rate). This acts as an insurance for the put sold. If the value of the underlying asset rises, both puts expire, and you are only left with the premium. Therefore, you only gain from the bull market condition. Did you know: Kotak Securities offers stock research insights for traders.

Strategy 3: Synthetic Long Call: Buy Stock, Buy Put

This is a conservative bull-market strategy. You may start out with a gut feeling that the markets are going to rise, but what if the prices fall? During this time, you will have to insure against your losses. You can do this by buying a put option. As discussed earlier, the put option gives you the right to sell the underlying stock at a pre-agreed strike price. In synthetic long call options, your strike price can be the price at which you bought the stock or a rate slightly below that. Since you are buying the put option, that acts as a hedge.

Strategy 4: Long Combo

Here, you sell a put and buy a call. This is a bull market strategy, i.e. you are expecting the markets to march north. In the long combo strategy, you sell the right to sell (put) at the OTM and buy the right to buy (call) at a higher strike rate OTM. This strategy starts making profits as the price of the underlying asset rises.

Strategy 5: Long Straddle

A straddle is a volatility strategy. Usually, it is used when you expect markets to show rapid movements. Here, you buy a call as well as a put for the same strike price and maturity date. By this, you can make the most when markets move in either direction. If the price of the stock/index increase, you can exercise your call option, while letting your put option expires. However, if the price falls, the put option can be exercised while the call option expires. In either case, you gain profit.

Strategy 6: Long Strangle

Long strangle is the cheaper version of the long straddle options strategy. Here, you buy a slightly OTM put and a slightly OTM call of the same underlying asset with the same expiration date. This is also a direction-neutral options strategy. However, in a long strangle, you require a higher movement on both sides to gain from the strategy. Therefore, a high level of volatility is required to exercise it.

Strategy 7: Long Call Butterfly

This options strategy can be exercised only when you are expecting the underlying asset to experience very minor price movements. The maximum reward in a long call butterfly is restricted, and gains occur only when the asset price is in the middle of the range at expiration.

Strategy 1: Bear Call Spread Strategy

This is the opposite of the bull call spread strategy. It is used when markets are either range-bound or marching south. Here, you sell the ITM call and buy the OTM call. You protect the downside of the call option sold by buying another call option of a higher strike price to insure the downfall.

Risk: The maximum loss is the difference between the two strike rates minus the net credit received.

Strategy 2: Bear Put Spread Strategy

A bear put spread strategy requires you to buy put and sell put. You buy a higher ITM put and sell a lower OTM put option. Thus, your net debit is created. However, you can gain only when the stock/index falls. The puts are bought to cap the asset downside. The sold puts will reduce your investment cost.

Strategy 3: Protective Call

This strategy is also called the synthetic long put options strategy. When you buy a call just to hedge, it is called the protective call strategy. When you choose the opposite position in a strategy just to avoid/reduce losses from one of the moves is called hedging. The best example of hedging is insurance. You hedge for the market upside while retaining your downside profit potential.

Strategy 4: Covered Put

Earlier in the piece, we had discussed how covered calls can protect your portfolio from downside risk. The covered put is just the opposite of the covered call strategy. You can use this strategy during neutral to bullish market conditions. Here, you can sell your put option during OTM conditions (when your strike price for the asset is higher than the market price of the asset). Selling the put means selling your right to sell.

Strategy 5: Short Straddle

This strategy is the opposite of the long straddle. If you feel that there is no substantial movement going to be experienced in the short run, you can go for the short straddle. You can sell the call and the put for the same asset, at the same strike price, for the same expiration date. However, if the markets move significantly in either direction, your losses can be enormous. To gain from the short straddle, your underlying asset value should be close to your strike price before the expiration date.

Strategy 6: Short Strangle

The short strangle strategy is similar to the short straddle strategy. It increases your benefits as the buyer of your option gets the least chance to exercise the option. Here, you sell a slightly OTM call and a slightly OTM put for the same option at the same strike rate and expiration date. The underlying asset price has to move significantly for the buyer of the option to exercise it. If the asset does not exhibit much movement, you get to keep the premium. Risk: You can face unlimited risk if the markets experience rapid movements.

Strategy 7: Short Call Butterfly

Here you buy 2 ATM call options, sell one ITM call option, and one OTM call option. Unlike the long call butterfly, it is for volatile markets. You will gain if there is a substantial rise in the index/stock. However, if there's a minor change in the underlying asset value during expiration, you will lose.

Strategy 8: Long Put Condor

This strategy is very similar to the long butterfly strategy. The difference is that the two ATM options sold have different strike rates, and the profitable area is wider than that of the long butterfly.

Strategy 9: Short Put Condor

This strategy is very similar to the short butterfly strategy. The only difference is that the two middle-bought options have different strike rates.

Strategy 1: Long Call:

If you are bullish about the stock performance, you can go for the long call. In simple terms, when you are positive about the growth of the stock price you have invested in, you can buy your right to buy (Call Option) to maximise your profit.

As discussed earlier, ‘call' is your right to buy. Here, you buy a ‘call' option after predicting that the market price of the underlying aster will rise above your strike price before the option expires. That is one of the most basic options strategies.

Strategy 2: Short Call

You can use this options strategy during bear market conditions. In a call option, you buy a call in case of a bull market, and during a bear market, you sell the call. This strategy involves unlimited risk. Therefore, a short call must be bought with utmost caution. This strategy is easy to execute. However, your reward is only limited to the premium. Here, you do not own the stock. Therefore, it is also called a ‘short naked call'.

Strategy 3: Long Put

As discussed earlier, the put option is the opposite of the call option. This is a bear market strategy and is used to limit risk from falling market conditions. When you buy put, you benefit from the bear market and limit your risk to the premium paid for buying the option. In a long put, your profit potential is unlimited.

Strategy 4: Short Put

Here, you sell a put option instead of buying it. You can sell the put when markets are bearish and can buy it during bull market conditions. Selling a put during market upswings helps you gain from the rising markets. By selling your put option, you have sold your right to sell the stock at your pre-agreed strike price.

If the price of the underlying asset rises above its strike price (during the market condition), the short put position will give you profit from the premium. This is because the buyer of the put option will not be able to exercise it. However, when the price of your underlying asset falls below your premium, you will face losses. The potential loss during the short put is unlimited.

Strategy 6: Covered Call

This strategy is for neutral to moderately bullish market conditions. If you own an asset whose price you expect to rise in the long term but stay bearish in the short run, you can go for a covered call. Here, you sell your right to buy for the stock you own. You can only exercise this option during the OTM conditions (the strike price of the underlying asset is greater than its market price). Until then, you can retain your premium. Since you sell (write) the call option after buying, it is also called the ‘buy-write strategy'.

Strategy 7: Collar

This strategy is quite similar to the covered call. However, there's a slight twist. Here, you further limit the covered call risk by buying a put to cover the downside and then finance the put by selling a call. Generally, put and calls are an OTM (Out of the Money). Both of these strategies should have the same expiration date, along with an equal number of shares. When the put limits your risk, the call also limits your gains. Therefore, it is a low-risk, low-reward options strategy.

There are several options trading strategies available for different market conditions. However, the core of this financial instrument is the same. Since it is an option, you have a choice of exercising it or not exercising it. This is unlike stocks, where you either buy or sell the asset. Through options strategies, you only trade the right to buy or sell. Options revolve around the world of ‘call' and ‘put'. Therefore, to gain maximum benefits, you must use them well. Options strategies can be a good approach for smart investing.

The following are some useful strategies for intraday options trading.

Strategy 1: Momentum Strategy

The strategy tries to profit from the market momentum. This entails monitoring the appropriate equities before a notable shift in the market trend occurs. Traders purchase or sell securities in response to this trend change. They consider a number of factors, including the most recent news, takeover announcements, quarterly profits, etc.

Intraday traders must review news related to the companies they have on their watchlist. There are several external factors influencing the share prices. So, intraday traders need to respond quickly in order to generate profits. The market's momentum determines the length of time an individual holds an asset.

Strategy 2: Breakout Strategy

Time is an important factor when purchasing and selling shares on the same day. This intraday trading approach aims to identify equities that have moved outside their typical trading range. One must spot equities entering a new price range. In other words, traders must identify the threshold limits at which share prices rise or fall. They may acquire shares and initiate long positions if the stock prices are above the predetermined level. If stock prices go below this level, you should sell the shares or consider taking on short positions.

Strategy 3: Reversal Strategy

There is a significant risk involved with this trading method. It entails calculations and analysis to trade against the market trends. The intraday trading approach is more challenging than the others. This is because you must possess in-depth market expertise. Moreover, it might be difficult to identify the price pullbacks and strengths precisely.

Strategy 4: Scalping Strategy

Scalping allows you to profit from small price fluctuations. This method is typically used for high-frequency trading. A complete technical or fundamental setup is not necessary here. Instead, price action is more important while using a scalping method. You must ensure that the equities they select are volatile and liquid. Also, use a stop loss for each order.

Strategy 5: Moving Average Crossover Strategy

A shift in momentum is indicated when the prices of an asset go above or below the moving average. An uptrend occurs when prices surpass the moving average. Conversely, a downtrend occurs when prices fall below the moving average. Experts advise taking long positions or purchasing equities during an upswing. You may sell the shares or take short positions during downtrends.

Strategy 6: Gap and Go Strategy

A key component of the gap-and-go strategy is identifying companies with minimal pre-market trading volume. Their beginning price differs from their closing price from yesterday. When a stock opens higher than it closed the previous day, it is known as a gap-up. On the other hand, the opposite situation is referred to as a gap down. Traders who use this strategy expect the gap to narrow before the trading day ends.

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FAQs on Options Strategies

The best strategy varies based on trading objectives. Popular ones include covered calls and spreads. Always look to align your strategy with risk tolerance and market outlook for optimal results.

Covered calls, owning stock, and selling calls, are some easy options trading strategies. They are considered beginner-friendly. However, the potential profits are limited.

Strategies like selling naked options, especially the puts, carry high risk. The potential for losses is unlimited, making it one of the riskiest strategies.

Protective puts and covered calls with defined risk are among the least risky strategies. The potential losses in these strategies are limited.

Long call or put options allow for significant profit potential with limited risk. Ideal for expressing a bullish or bearish view.

Strategies with limited risks, like covered calls or protective puts, are considered safer. Tailor an approach to match your risk tolerance.

Begin by understanding the basics. Learn the strategies and practice with virtual trading platforms. Gradually implement actual trades as you become confident.

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