Too often, traders jump into the options game with little or no understanding of how many options strategies are available to limit their risk and maximize return. With a little bit of effort, however, traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction.
Aside from purchasing a naked call option, you can also engage in a basic covered call or buy-write strategy. In this strategy, you would purchase the assets outright, and simultaneously write or sell a call option on those same assets. Your volume of assets owned should be equivalent to the number of assets underlying the call option.
Investors will often use this position when they have a short-term position and a neutral opinion on the assets, and are looking to generate additional profits through receipt of the call premium , or protect against a potential decline in the underlying asset's value.
In a married put strategy, an investor who purchases or currently owns a particular asset such as shares , simultaneously purchases a put option for an equivalent number of shares. Investors will use this strategy when they are bullish on the asset's price and wish to protect themselves against potential short-term losses. This strategy essentially functions like an insurance policy, and establishes a floor should the asset's price plunge dramatically.
For more on using this strategy, see Married Puts: In a bull call spread strategy, an investor will simultaneously buy call options at a specific strike price and sell the same number of calls at a higher strike price. Both call options will have the same expiration month and underlying asset. This type of vertical spread strategy is often used when an investor is bullish and expects a moderate rise in the price of the underlying asset. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price.
Both options would be for the same underlying asset and have the same expiration date. This method is used when the trader is bearish and expects the underlying asset's price to decline. It offers both limited gains and limited losses. For more on this strategy, read Bear Put Spreads: Now that you've learned a few different options strategies, if you're ready to take the next step and learn to:.
A protective collar strategy is performed by purchasing an out-of-the-money put option and writing an out-of-the-money call option at the same time, for the same underlying asset such as shares. This strategy is often used by investors after a long position in a stock has experienced substantial gains.
In this way, investors can lock in profits without selling their shares. A long straddle options strategy is when an investor purchases both a call and put option with the same strike price, underlying asset and expiration date simultaneously. An investor will often use this strategy when he or she believes the price of the underlying asset will move significantly, but is unsure of which direction the move will take.
This strategy allows the investor to maintain unlimited gains, while the loss is limited to the cost of both options contracts. In a long strangle options strategy, the investor purchases a call and put option with the same maturity and underlying asset, but with different strike prices. The put strike price will typically be below the strike price of the call option, and both options will be out of the money.
An investor who uses this strategy believes the underlying asset's price will experience a large movement, but is unsure of which direction the move will take. Losses are limited to the costs of both options; strangles will typically be less expensive than straddles because the options are purchased out of the money.
All the strategies up to this point have required a combination of two different positions or contracts. In a butterfly spread options strategy, an investor will combine both a bull spread strategy and a bear spread strategy, and use three different strike prices.
For example, one type of butterfly spread involves purchasing one call put option at the lowest highest strike price, while selling two call put options at a higher lower strike price, and then one last call put option at an even higher lower strike price. An even more interesting strategy is the i ron condor. In this strategy, the investor simultaneously holds a long and short position in two different strangle strategies.
The iron condor is a fairly complex strategy that definitely requires time to learn, and practice to master. The final options strategy we will demonstrate here is the iron butterfly. In this strategy, an investor will combine either a long or short straddle with the simultaneous purchase or sale of a strangle.
Although similar to a butterfly spread , this strategy differs because it uses both calls and puts, as opposed to one or the other. Profit and loss are both limited within a specific range, depending on the strike prices of the options used. Investors will often use out-of-the-money options in an effort to cut costs while limiting risk.
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Become a day trader. Investopedia Academy "Options for Beginners". Now that you've learned a few different options strategies, if you're ready to take the next step and learn to: Improve flexibility in your portfolio by adding options Approach Calls as down-payments, and Puts as insurance Interpret expiration dates, and distinguish intrinsic value from time value Calculate breakevens and risk management Explore advanced concepts such as spreads, straddles, and strangles Check out Investopedia Academy's Options for Beginners Course.
Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons. Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
If you want to take advantage of the versatility of options, you'll need to adopt these smart investing habits and traits.
Stocks are not the only securities underlying options. Trading options is not easy and should only be done under the guidance of a professional. Learn more about stock options, including some basic terminology and the source of profits. For individuals aspiring to become options traders, here are five of the best books that offer help in understanding and profiting from the options markets.
Index options are less volatile and more liquid than regular options. Understand how to trade index options with this simple introduction. A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. Passive investing is an investment strategy that limits buying and selling actions. Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life.
If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. Get Free Newsletters Newsletters.More...