While the options market is risky and not suitable for everyone, these contracts can be a tool to make a speculative bet or offset risk in another position.
Many option strategies can involve one “leg,” meaning there’s only one contract that’s traded. More sophisticated strategies involve buying or selling multiple options contracts at the same time in order to minimize risk.
Here’s a guide that covers 10 important options trading strategies–from the most basic to the more complex and advanced.
Options Trading Basics
Options are derivatives contracts that give holders the right—not the obligation—to buy or sell a particular asset at a specific price by a set date in time. With stock options, holders of the contracts have the right to buy the underlying shares. A single stock options contract typically represents the right to buy or sell 100 shares.
Here are the differences of calls vs. puts–the two main types of options:
• A call gives the holder the right to buy an asset—it’s a bet that the price will rise.
• A put gives the holder the right to sell an asset— it’s a bet that the price will fall.
Basic Options Terminology to Know
Options contracts have two components: an expiration date and a strike price.
• The expiration date is the last day by which an investor has to exercise their option. Otherwise, the options contract expires worthless.
• The strike price is the price at which the options holder can exercise the contract. Let’s say a call option has a strike price of $100. It can be exercised once the price of the underlying stock rises to $100.
There are also three categories contracts can fall into, depending on where the price of their underlying security lies in relation to their strike price.
• “In-the-money” means an option is already profitable, i.e., the stock price is below the strike for a put, or the stock price is above the strike price for a call.
• “Out-of-the-money” means the opposite, i.e., the stock is trading higher than the strike for a put, or the stock price is trading lower than the strike for a call.
• “At-the-money” means the strike price of the option and the stock price are about the same.
Common Options Trading Strategies
When trading options, investors can either buy existing contracts, or they can “write” or sell contracts for securities they currently hold. The former is generally used as a means of speculation, while the latter is most often used as a way of generating income.
Here’s a closer look at important options strategies for beginner, intermediate and more advanced investors to know.
Beginner Options Strategies
1. Long Calls
Being long a call option means an investor has purchased a call option. “Going long” calls are a very traditional way of using options. This strategy is often used when an investor has expectations that the share price of a stock will rise but may not want to outright own the stock. It’s therefore a bullish trading strategy.
Let’s say an investor believes that Retail Stock will climb in one month. Retail Stock is currently trading at $10 a share and the investor believes it will rise above $12. The investor could buy an option with a $12 strike price and with an expiration date at least one month from now. If Retail Stock’s price rises to hit $12 within a month, the value or “premium” of the option would likely rise.
2. Long Puts
Put options can be used to make a bearish speculative bet, similar to shorting a stock, or they can also function as a hedge. A hedge is something an investor uses to make up for potential losses somewhere else. Here are examples of both uses.
Let’s say Options Trader wants to wager shares of Finance Firm will fall. Options Trader doesn’t want to buy the shares outright so instead purchases puts tied to Finance Firm. If Finance Firm stock falls before the expiration date of the puts, the value of those options will likely rise. And Options Trader can sell them in the market for a profit.
An example of a hedge might be an investor who buys shares of Tech Stock C that are currently trading at $20. But the investor is also nervous about the stock falling, so they buy puts with a strike price of $18 and an expiration two months from now.
One month later, Tech Stock C stock tumbles to $15, and the investor needs to sell their shares for extra cash. But the investor capped their losses because they were able to sell the shares at $18 by exercising their puts.
3. Covered Calls
The covered call strategy requires an investor to own shares of the underlying stock. They then write a call option on the stock and receive a premium payment.
The tradeoff is that if the stock rises above the strike price of the contract, the stock shares will be called away from them, and the shares (along with any future price rises) will be forfeit. So, this strategy works best when a stock is expected to stay flat or go down slightly.
If the stock price of Company Y stays below the strike price when the option expires, the call writer keeps the shares and the premium and can then write another covered call if desired. If Company Y rises above the strike price when the option expires, the call writer must sell the shares at that price.
4. Short Puts
Being short a put is similar to being long a call in the sense that both strategies are bullish. However, when shorting a put, investors actually sell the put option, earning a premium through the trade. If the buyer of the put option exercises the contract however, the seller would be obligated to buy those shares.
Here’s an example of a short put: Shares of Transportation Stock are trading at $40 a share. An investor wants to buy the shares at $35. Instead of buying shares however, the investor sells put options with a strike price of $35. If the shares never hit $35, the investor gets to keep the premium they made from the sale of the puts.
Should the options buyer exercise those puts when it hits $35, the investor would have to buy those shares. But remember the investor wanted to buy at that level anyways. Plus by going short put options, they’ve also already collected a nice premium.
Intermediate Options Strategies
These are more complex options strategies that are appropriate for experienced traders and investors.
5. Short Calls or Naked Calls
When an investor is short call options, they are typically bearish or neutral on the underlying stock. The investor typically sells the call option to another person. Should the person who bought the call exercise the option, the original investor needs to deliver the stock.
Short calls are like covered calls, but the investor selling the options don’t already own the underlying shares, hence the phrase “naked calls”. Hence they’re riskier and not for beginner investors.
Here’s a hypothetical case: Investor A sells a call option with a strike price of $100 to Trader B, while the underlying stock of Energy Stock is trading at $90. This means that if Energy Stock never rises to $100 a share, Investor A pockets the premium they earned from selling the call option.
However, if shares of Energy Stock rise above $100 to $115, and Trader B exercises the call option, Investor A is obligated to sell the underlying shares to Trader B. That means Investor A has to buy the shares for $115 each and deliver them to Trader B, who only has to pay $100 per share.
6. Straddles and Strangles
With straddles in options trading, investors can profit regardless of the direction the underlying stock or asset makes. In a long straddle, an investor is anticipating higher volatility, so they buy both a call option and a put option at the same time. Short straddles are the opposite–investors sell a call and put at the same time.
Straddles and strangles are used when movement in the underlying asset is expected to be small or neutral.
Let’s look at a hypothetical long straddle. An investor pays $1 for a call contract and $1 for a put contract. Both have strikes of $10. In order for the investor to break even, the stock will have to rise above $12 or fall below $8. This is because we’re taking into account the $2 they spent on the premiums.
In a long strangle, the investor buys a call and put but with different strike prices. This is likely because they believe the stock is more likely to move up than down, or vice versa. In a short strangle, the investor sells a call and put with different strikes.
Here’s an example of a short strangle. An investor sells a call and put on an exchange-traded fund (ETF) for $3 each. The maximum profit the investor can make is $6 — the total from the sales of the call and the put options. The maximum loss the investor can incur is unlimited since the underlying ETF can potentially climb higher forever. Meanwhile, losses would stop when the price hit $0 but still be significant.
7. Cash-Secured Puts
The cash-secured put strategy is one that can both provide income and let investors purchase a stock at a lower price than they might have been able to if using a simple market buy order.
Here’s how it works: an investor writes a put option for Miner CC they do not own with a strike price lower than shares are currently trading at. The investor needs to have enough cash in their account to cover the cost of buying 100 shares per contract written, in case the stock trades below the strike price upon expiration (in which case they would be obligated to buy).
This strategy is typically used when the investor has a bullish to neutral outlook on the underlying asset. The option writer receives cheap shares while also holding onto the premium. Alternatively, if the stock trades sideways, the writer will still receive the premium, but no shares.
Advanced Options Strategies
These are some of the most complex options strategies that involve multiple contracts. They are more appropriate for investors and traders with significant experience in markets and options.
8. Bull Put Spreads
A bull put spread involves one long put with a lower strike price and one short put with a higher strike price. Both contracts have the same expiration date and underlying security. This strategy is intended to benefit from a rising stock price. But unlike a regular call option, a bull put spread limits losses and can also profit from time decay.
Let’s say a stock is trading at $150. Trader B buys one put option with a strike of $140 for $3, while selling another put option with a strike of $160 for $4. The maximum profit is $1, or the net earnings from the two options premiums. So $4 minus $3 = $1. The maximum profit can be achieved when the stock price goes above the higher strike, so $160 in this case.
Meanwhile, the maximum loss equals the difference between the two strikes minus the difference of the premiums. So ($160 minus $140 = $20) minus ($4 minus $3 = $1) so $20 minus $1, which equals $19. The maximum loss is achieved if the share price falls below the strike of the put option the investor bought, so $140 in this example.
9. Iron Condors
The iron condor consists of four option legs (two calls and two puts) and is designed to earn a small profit in a low-risk fashion when a stock is thought to have little volatility. Here are the four legs. All four contracts have the same expiration:
1. Buy an out-of-the-money put with a lower strike price
2. Write a put with a strike price closer to the asset’s current price
3. Write an call with a higher strike
4. Buy a call with an even higher out-of-the-money strike.
If an individual makes an iron condor on shares of Widget Maker Inc., the best case scenario for them would be if all the options expire worthless. In that case, the individual would collect the net premium from creating the trade.
Meanwhile, the maximum loss is the difference between the long call and short call strikes, or the long put and short put strikes, after taking into account the premiums from creating the trade.
10. Butterfly Spreads
A butterfly spread is a combination of a bull spread and a bear spread and can be constructed with either calls or puts. Like the iron condor, the butterfly spread involves four different options legs. This strategy is used when a stock is expected to stay relatively flat until the options expire.
In this example, we’ll look at a long-call butterfly spread. To create a butterfly spread, an investor buys or writes four contracts:
1. Buys one in-the-money call with a lower strike price
2. Writes two at-the-money calls
3. Buys another higher striking out-of-the-money call.
Options trading strategies offer a way to potentially profit in almost any market situation—whether prices are going up, down, or sideways. The market is complex and highly risky, making it not suitable for everyone, but the guide above lays out different trading strategies based on the level of expertise of the investor.
Investors can get help with trading strategies from educational resources and financial planners on SoFi Invest®. Investors can use the Active Investing platform to trade company stocks, fractional shares and ETFs without incurring commissions.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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