Best Options Trading Strategies
Best Options Trading Strategies
Are you feeling a little overwhelmed by the term "Options Strategies"? Don't worry, we're here to make it easy for you to understand.
Imagine a game called "lotto," where you buy a ticket and hope to win a big prize, even though the chances of winning are very low. It's like a jackpot game. Well, when we talk about trading in options, it's a bit like that lotto game. There's a risk involved, but people still take part because they hope to make a big profit, just like winning the lotto.
But here's the interesting part: experienced options traders treat options differently. They use options as a way to protect themselves from risks or to make smart plans to make money while avoiding big losses. This is where you want to be if you're trading options.
In reality, there are some special strategies for trading options. These strategies are like secret tricks that help reduce the risk and open the door to making lots of money.
In this blog, we're going to talk about these option trading strategies. We'll explain them with examples so that even if you're new to this, you can understand and use these strategies when you trade options.
What is Options Trading?
Option Trading Strategies are like tools that help people make money by buying or selling special contracts. These contracts are called "options." Options can be used to protect yourself from losing too much money and to make a lot of money if things go well.
Let's break it down. There are two main types of options: call options and put options. Imagine you want to buy a fancy toy, but you're not sure if you'll have enough money when you get to the store. You can use a call option to say, "I want the toy at today's price, but I'll come back later to buy it." The store can't sell the toy to anyone else while you have this option. On the other hand, if you have a put option, it's like saying, "I have this toy, and I promise to sell it to you at a certain price, but only if you want it before a certain date." So, you have the right to sell the toy, but you don't have to if you don't want to.
Now, Option Trading Strategies are like recipes for making money using these options. You can use them to make money when you think the prices will go up (bullish), when you think they will go down (bearish), or when you're not sure which way they will go (neutral).
Know in detail about what are options
For example, let's say you believe that a new movie will make a toy very popular, and you want to make money from it. You could use a bullish strategy. It's like buying the toy at a discount and selling it for more when it becomes popular. If you're right, you make a lot of money!
But what if you think that the toy store will have a big sale soon, and the prices will drop? That's where a bearish strategy comes in. You can use it to make money when prices go down. It's like selling your toy at a high price now and buying it back when it's cheaper. If you're right, you make money again!
And sometimes, you're not sure what will happen. Maybe you heard rumors about the toy, but you're not sure if they're true. In that case, you can use a neutral strategy. It's like saying, "I'll buy the toy at today's price, but if it gets cheaper, I'll also buy it at a lower price." This way, you don't miss out on any good deals.
So, Option Trading Strategies are like your secret recipe book for making money with options. You choose the strategy that fits the situation, and it helps you make money while protecting you from losing too much. It's like a game where you can win big if you play your cards right!
Now, isn't that exciting? Option Trading Strategies can be a powerful tool to help you make money in the stock market. But remember, like any game, it's important to learn the rules and be careful with your choices. With the right strategies, you can make your money work for you and bring excitement to your financial journey.
List of best options trading strategies
Bullish Options Trading Strategies
1). Bull Call Spread
A "Bull Call Spread" is a strategy used by investors to make money when they believe that the price of a particular stock is going to go up. It's like a way to bet on a stock going up in price.
How it works:
● Two Types of Calls: First, you need to know about something called a "call option." A call option is like a special ticket that gives you the right to buy a stock at a certain price. In the Bull Call Spread strategy, you buy one call option and sell another call option.
● Same Stock and Date: Both of these call options should be for the same company's stock, and they should have the same date when they expire. This means they both have an expiration date, like the last day you can use them.
● Profit and Loss: With the Bull Call Spread, you can make a profit if the stock's price goes up. Your profit is the difference between the two call options' prices, minus the cost you paid to buy them. But if the stock's price goes down, you might lose some money. Your loss is equal to the cost you paid to buy the call options.
● Spreads and Debit: We also have something called "spread" and "net debit" in this strategy. The spread is just the difference between the prices of the two call options. Net debit is the money you spend to buy the cheaper call option minus the money you receive when you sell the more expensive one.
● Protection: The Bull Call Spread can also help protect you if the stock's price falls. It's like a safety net for your investment. Your losses are limited because you're selling one call option while buying another.
● Capped Profits and Losses: What's interesting is that both the profit and loss are limited or "capped." This means you can't make unlimited money, but you also can't lose more than a certain amount. It's like having a maximum and minimum amount of profit or loss.
● Not Too Aggressive: This strategy is a good choice when you believe a stock will go up, but you don't want to take a very aggressive bet by just buying a call option. It's a way to be a bit more cautious while still trying to make a profit.
In simple terms, a Bull Call Spread is like buying and selling special tickets for a stock ride. You buy one that's not too expensive and sell another that's more expensive. If the stock goes up, you can make some money, but if it goes down, you won't lose too much. It's a way to be a smart investor when you're feeling positive about a company's stock.
2). Bull Put Spread
Do you want to know about a strategy in the stock market that is called "Bull Put Spread"? Well, it's one of the ways that people use when they think the price of a stock will go up a little. But don't worry; we'll explain it in simple words.
Imagine you have a favorite game, and you believe that the game is going to get better, but not by a lot. This is how some people feel about stocks. They think the stock's price will go up a bit, but not too much.
Now, let's talk about the Bull Put Spread strategy. It's a bit like making a bet, but in the stock market. Instead of betting on the stock going up, you are betting on it not going down too much.
Here's how it works:
● Step 1: You choose two special things called "put options." Think of them like tools you can use to make your bet.
● Step 2: One of these tools is called an "OTM Put option." The other one is an "ITM Put option." These tools are related to the same game (stock), and they should have the same expiration date. This means that your bet is only valid for a certain amount of time.
● Step 3: The OTM Put option is like saying, "I bet that the stock won't fall too much." You buy this one.
● Step 4: The ITM Put option is like saying, "If the stock does fall a lot, I've got a plan to protect myself." You sell this one.
Now, you might wonder what happens when the game (stock) starts playing. If the stock price goes up or stays the same, you win! You make some money. But there's a limit to how much you can win, and it's not a lot.
But what if the game doesn't go your way, and the stock price falls too much? Don't worry; you won't lose too much. Your loss is limited, and it only happens if the stock falls below a certain price, called the "strike price" of the OTM Put option.
So, in simple terms, the Bull Put Spread strategy is like saying, "I think the stock will do okay or get a little better, but I'm ready if it doesn't." It's a way to make a special kind of bet in the stock market that doesn't put all your money at risk.
Remember, this strategy can help you when you're feeling a bit positive about a stock, but not too sure if it will go way up. Just like in any game, it's important to be careful and know the rules. And if you ever want to use this strategy, make sure you understand it well and consider getting advice from experts.
3). Long Call Butterfly
Investing in the stock market can be a bit tricky, especially for those who are new to it. But don't worry; we are here to explain a popular strategy called the "Long Call Butterfly" in simple English. This strategy can help you make some money, and we'll break it down for you step by step.
What is the Long Call Butterfly Strategy? The Long Call Butterfly Strategy may sound complicated, but it's not as hard as it seems. It's a way to make money in the stock market by using options, which are like special contracts.
Here's how it works:
● Buy Two Call Options: First, you buy two call options. These are like bets that the price of a stock will go up. Imagine you're saying, "I think the stock price will rise!"
● Use Different Strike Prices: These call options have different "strike prices." Strike prices are like goals for the stock price. You choose these goals, and they should be equally spaced. Think of them as three levels: low, middle, and high.
● Sell Two Call Options in the Middle: Next, you sell two more call options, but these are in the middle of the three levels you picked earlier. So, you sell options between the low and middle strikes, and between the middle and high strikes.
What Happens Next? Now that you have bought and sold these options, let's see what can happen:
● If the stock price goes up and lands on the middle strike price on the day when your options expire, congratulations! You make a profit.
● The profit you make is limited. It's like the reward for being right about the stock price going to that middle strike price. The amount you make is the difference between the middle strike price and the lower strike price, minus the cost you paid to buy all those options in the first place.
Why Is It Called a Butterfly? The Long Call Butterfly Strategy is named after a butterfly because if you draw a picture of it, it looks like a butterfly with its wings open. The middle strike price is like the body of the butterfly, and the other two strike prices are like the wings.
4). Long Iron Condor
Think of the Long Iron Condor as the opposite of something called the "long call butterfly." It involves doing two things: buying and selling call options. But don't worry; we'll explain what that means.
First, let's understand the basics of this strategy. It's used when you believe that a certain stock or investment is going to do well. In other words, you're feeling positive or "bullish" about it. Now, instead of just buying or selling the stock itself, you can use options to make your investment.
Options are like special contracts that give you the right to buy or sell a stock at a specific price in the future. When you buy an option, it's like making a bet that the stock price will go up. When you sell an option, it's like making a bet that the stock price will go down or stay the same.
How Long Iron Condor strategy works:
● You start by picking two call options with different prices. These are like your tools for making a bet on the stock.
● Next, you sell one of those call options to someone else. This is a bit like saying, "I'm willing to bet that the stock won't go above this price."
● After that, you buy two more call options with prices in between the ones you already have. This is where it gets a bit clever. It means you're making a second bet, but this time, it's like saying, "I think the stock will stay between these two prices."
Now, let's talk about the outcomes:
● If the stock price goes up a lot, you might lose some money. But your loss is limited to the amount you paid when you bought those two middle call options. That's your "net premium paid."
● If the stock price stays between the two middle prices you chose, you can make a profit. The profit you make is equal to the difference between the lowest two prices minus what you paid when you bought those middle call options.
So, in simple words, the Long Iron Condor strategy is a way to make a bet on a stock going up, but with a safety net. It's like saying, "I think the stock will do well, but just in case it doesn't go too high or too low, I want to protect my money."
5). Call Ratio Back Spread
Imagine you want to make smart choices when it comes to investing your money. One strategy you can consider is called the "Call Ratio Back Spread." This strategy may sound a bit complicated, but we'll explain it in simple terms.
In this strategy, you do two main things: you buy more options than you sell, and these options have different prices at which you can buy or sell the asset. Specifically, you buy two options and sell one.
How break down works:
● Buying More Than You Sell: When we say you buy more options than you sell, it means you are getting two chances to benefit from the price movement of a particular asset. These options give you the right to buy the asset at a certain price in the future.
● Different Strike Prices: Each option has something called a "strike price." This is the price at which you can buy or sell the asset. In the Call Ratio Back Spread, the two options you buy have different strike prices. This difference in strike prices is crucial to how this strategy works.
● One Short Call: Along with buying these two options, you also sell one option. This option is called a "short call." Selling this option means you're promising to sell the asset at a specific price in the future if someone decides to buy it from you.
What happens in break down strategy:
● Limiting Losses: Because you have two long calls (the ones you bought), your potential losses are limited. You already have the right to buy the asset at two different prices, so even if the asset's price drops, you won't lose everything.
● Unlocking Unlimited Gains: This is where the Call Ratio Back Spread gets interesting. By selling one short call, you're actually creating a situation where you could make unlimited gains if the asset's price goes up a lot.
● If the asset's price goes up a little or stays the same, your short call doesn't get exercised, and you keep the money you got for selling it.
● If the asset's price goes up a lot, the person who bought your short call may want to buy the asset from you at the lower price you promised. But you can buy it at the lower strike price from the long call you bought. The difference between the two strike prices becomes your profit.
Maximum Loss: However, there's a catch. The maximum loss you can face with this strategy happens when the asset's price goes up so much that it reaches the strike price of the higher long call you bought. At that point, your losses are limited to the difference between the two strike prices.
In simple terms, the Call Ratio Back Spread is a strategy that allows you to have more potential for gains while limiting your losses. It's like having two chances to make money if the asset's price goes up, and you're protected from losing too much if it goes down.
6). Synthetic Long Call
The Synthetic Long Call strategy is a smart way to make gains in the stock market when you expect a particular stock's price to rise. Let's break it down step by step:
● Buying and Holding Shares: First, as an investor, you buy and hold shares of a stock that you believe will increase in value. This means you become a part-owner of the company, and you may enjoy certain benefits like receiving dividends (a share of the company's profits) and having voting rights in company decisions.
● Buying Put Options: Now, here's where the Synthetic Long Call strategy gets interesting. In addition to buying the actual shares, you also buy something called "put options." These put options are like a kind of insurance. They give you the right, but not the obligation, to sell your shares at a specific price (called the strike price) in the future.
Why Buy Put Options? You might wonder why you'd want to buy put options. Well, here's the trick: these put options are positioned opposite to your outlook. In other words, they protect you in case the stock price goes down instead of up. So, if your prediction about the stock price rising doesn't come true, you can use the put options to sell your shares at the strike price and limit your losses.
Benefits of the Synthetic Long Call Strategy:
The Synthetic Long Call strategy offers some significant advantages:
● Dividends and Voting Rights: By buying and holding shares, you get to enjoy dividends and voting rights. Dividends are like a bonus you receive from the company, and voting rights allow you to have a say in important company decisions.
● Protection: The put options act as a safety net. If the stock price doesn't go as you expected, you can use the put options to minimize your losses.
● Unlimited Gains: One exciting aspect of this strategy is the potential for unlimited gains. While there is a limit to how high stock prices can go, there is no strict limit on your profits. If the stock price goes up significantly, your gains can be substantial.
In summary, the Synthetic Long Call strategy is a useful tool for Indian investors who want to benefit from rising stock prices while still having protection in case things don't go as planned. It allows you to enjoy the perks of being a shareholder, such as dividends and voting rights, while also having a safety net in the form of put options.
7). Diagonal Call Spread
The Diagonal Call Spread strategy is like a clever puzzle in the world of stock market investments. To grasp it better, let's break it down step by step.
● Call Options: In the stock market, a call option gives you the right to buy a stock at a specific price (called the strike price) before a certain date (the expiration date).
● Different Expiration Dates: With a Diagonal Call Spread, you do two things. First, you buy a call option, and this one has a longer time before it expires. Imagine this like having a longer-term plan.
● Different Strike Prices: Next, you sell another call option, but this one has a shorter time before it expires. However, it has a higher strike price. Think of this as a shorter-term but more challenging option.
Now, here's where it gets interesting.
The "Diagonal" Part: This strategy gets its name because it combines two essential elements:
● Horizontal Spread: This means the two call options have different expiration dates.
● Vertical Spread: This means the two call options have different strike prices.
Let's put it all together with an example.
Suppose you're interested in buying shares of a company listed on the Indian stock market, say ABC Ltd. The current price of ABC Ltd.'s shares are ₹1,000.
● Buying the Call Option (Longer Expiration Date): You decide to buy a call option with a longer expiration date, let's say 6 months from now. This option has a strike price of ₹950. So, you're locking in the right to buy ABC Ltd. shares at ₹950 anytime within the next 6 months.
● Selling the Call Option (Shorter Expiration Date, Higher Strike Price): Simultaneously, you sell another call option, which expires in 3 months, but this one has a higher strike price of ₹1,050. Here, you're giving someone else the right to buy ABC Ltd. shares from you at ₹1,050 within the next 3 months.
Why Do This? By using the Diagonal Call Spread strategy, you are:
● Taking advantage of a potentially rising stock price because you have the right to buy at ₹950, even if the market price goes higher.
● Collecting a premium by selling the second call option with a higher strike price, which can help offset your initial investment.
The Diagonal Call Spread strategy is a bit like having a long-term plan while also taking advantage of short-term opportunities. It combines different expiration dates and strike prices to potentially benefit from rising stock prices and premium collection.