Overview
Options trading is a profitable instrument to hedge risks of trading stocks, futures, etc. Yet, it is as easy as it says as you need to invest time and effort in learning the best practices and mastering the fundamentals. This article walks you through the top basic strategies that every option trader should know to navigate trades to the land of profit.
Call Options
A call option offers the right to buy the underlying asset. It can be a stock, currency, futures contract, etc. The note is that there are set prices and expiration dates. Yet, as the name suggests, you can either buy or hold an option at the strike price. It is different from futures trading which requires an obligation.
An option is a derivative contract between two parties. When calling options, you expect the price will increase at a higher level than the strike price. So, it will go beyond the strike price by the expiration date. If things go well, the holder can earn profits from the difference between buying and reselling prices!
In addition, you have to pay a premium, the fee to own an option contract. It is a cost for the seller to set up and process a deal with you. The premium anchors on the proportion of possible trade sizes. So, you can be exposed to risks or have potential losses when paying for the premium.
Put Options
Unlike call options, a put option provides the right to sell a stock, commodity futures contract, etc. It is essential that the buyer of the put option short the underlying asset. The expectation is that the market price will go lower than the strike price. The purpose is to buy the asset at a cheaper price, then resell it at a higher price when agreeing on the strike price!
Open & Close Options
If you start trading options, you should update your knowledge about some common terms. “Buy to open” illustrates the buying of a trader, whether it is a put or call option. The open interest will consequently increase in a specific option, which generates higher liquidity.
“Sell to close” signifies when a holder of the options sells their calls or puts positions for the net profit or loss. Mind you that an options contract has expired dates. It means that in-the-money options will be valid but dwindle in value through time and out-of-the-money options will end up worthless.
Also, you may sell to open to minimize the potential losses when there is a signal of the rising short call position. Meanwhile, an option writer can buy to close if they need to close out a call or put an option to maximize their earnings and downsize risks.
Other common terminologies that you should be familiar with to earn more from options trading are:
Vertical call/put spread: It is a strategy to gain profits in both bearish and bullish markets. The bear spreads and bull spreads are what you can call them, respectively!
Calendar Spread: It signifies that you can buy or sell an option with one maturity to sell or buy another with a different maturity.
Straddle: It means that you buy a call and a put having the same strike prices and expiring on the same day.
Straggle: It indicates that you buy a call and a put having the same expired date but at different strikes.
Butterfly: It is a strategy that stays neutral between selling and buying a strangle.
Covered Call: It refers to selling shares that have directions against an existing stock position.
Protective Put: It mentions the action of buying against a present stock position.
Before You Go
If you are totally new to options trading markets, the thing you should overlook the least is the fundamentals. Reading charts or learning to trade options requires a good grasp of strategies, tools, and common terms.
We share the summary of four basic strategies that you can apply to options trading right away. Hopefully, we hope you find the information in this article helpful to enhance your trading knowledge and skills.
References:
https://www.oreilly.com/library/view/understanding-leaps-using/9780071383868/ch02.html
https://www.investopedia.com/ask/answers/sell-open-buy-close-buy-open-sell-close-mean/