Editor's Note: Options are not suitable for all investors. 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. Please see the Characteristics and Risks of Standardized Options.
Although options investing involves significant risk and may not be suitable for all investors, those who understand how to trade derivatives contracts can use them to make a speculative bet or offset risk in another position.
Options trading involves buying and selling options contracts. These contracts give investors the right — but not always the obligation — to buy or sell securities at a specified price before a certain date. Options contracts are commonly used for speculation (investors who want to turn a profit on a presumption about the market) or as a way to hedge other investments (as an attempt to offset potential losses).
Trading options can offer profit opportunities but also carries substantial risk, and requires a clear understanding of the strategies involved.
Key Points
• Options trading involves buying and selling contracts to speculate or hedge investments, offering unique profit opportunities but with significant risks.
• Understanding risks and mechanics in options trading is crucial for aligning strategies with market outlook, goals, and risk tolerance.
• Key strategies include long calls, long puts, covered calls, short puts, short calls, straddles and strangles, cash-secured puts, bull put spreads, iron condors, and butterfly spreads.
• Effective options trading requires aligning strategies with one’s expertise, market outlook, and risk tolerance.
• Advanced strategies like iron condors and butterfly spreads target low volatility environments, utilizing complex positions to capitalize on minimal price movements.
10 Important Options Trading Strategies for Every Investor
In options trading, 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.
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 closer look at important options strategies for beginner, intermediate, and more advanced investors to know.
1. Long Calls
Level of Expertise: Beginner
A long call is an options strategy where an investor buys a call option (also known as “going long”), anticipating that the price of the underlying asset will rise before the contract expires. 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 considered a bullish trading strategy.
For example, an investor believes that a stock will climb in one month. The investor could buy an option with a strike price that’s higher than the current share price, with an expiration date at least one month from now. If the stock’s price rises to $12 within a month, the premium on the option will likely rise as well, which can generate a profit for the investor (minus fees).
If the stock does not rise to the strike price, the contract expires worthless, costing the investor the premium.
2. Long Puts
Level of Expertise: Beginner
Put options can be used to take a bearish position, similar to shorting a stock. They can also function as a hedge, which is a strategy traders use to offset potential losses in other positions. Here are examples of both uses.
Let’s say an options trader believes that a firm will have disappointing quarterly results and wants to take a position that could benefit from a decrease in its share value. The options trader doesn’t want to buy the company’s shares outright, so instead they purchase put options tied to the company.
If the company’s stock falls before the expiration date of the puts, the value of those options will likely rise. The options trader can sell them in the market, realizing a gain. If the stock price stays above the strike price, the puts expire worthless, and the trader loses the premium they paid.
An example of a hedge might be a trader who buys shares of a company that is trading at a level they are satisfied with. The investor might also be concerned about the stock falling, however, so they buy puts with a strike price that’s lower than the current stock price, and with an expiration date that is two months from now.
The potential losses on the trader’s position are capped at the strike price of the puts, minus the premium paid. If the stock falls below the strike price of the contracts, they can sell at the strike price instead, capping their losses. Alternatively, if the stock price stays the same or goes higher, the contracts expire worthless and the trader loses the premium.
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3. Covered Calls
Level of Expertise: Beginner
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.
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 forfeited. This strategy is considered relatively conservative because it can generate income from the premium while capping potential upside. Risks still exist if the stock price declines significantly.
If the price of a stock 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 the shares rise above the strike price when the option expires, the call writer must sell the shares at that price.
4. Short Puts
Level of Expertise: Beginner
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 sell those shares.
Here’s an example of a short put: shares of a stock are trading higher than usual, and an investor wants to buy the shares at a slightly lower price. Instead of buying shares however, the investor sells put options with a strike price that reflects the price they are willing to pay for the stock. If the shares never hit strike price, the seller of the options contracts gets to keep the premium they made from the sale of the puts to the investor.
However, if the options buyer exercises those puts, the seller would be obligated to purchase the shares at the strike price, regardless of the current market price. This could result in a loss for the seller if the market price is significantly lower than the strike price.
5. Short Calls or Naked Calls
Level of Expertise: Intermediate
When an investor is short on call options, they are typically bearish or neutral on the underlying stock, and may sell 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 similar to covered calls, but in this case, the investor selling the options doesn’t already own the underlying shares, hence the term “naked calls.” This makes them riskier, and not a fit for beginner investors.
For example, if an investor sells a call option at a strike price higher than the stock price to a trader. If that stock never rises to the strike price, the investor pockets the premium they earned from selling the call option.
However, if the shares rise above the strike price, and the trader exercises the call option, the investor is obligated to sell the underlying shares to the trader. In this case, the investor must then purchase the shares at the current market price to sell them to the trader at the agreed-upon strike price to cover the transaction.
6. Straddles and Strangles
Level of Expertise: Intermediate
Straddles are an options strategy in which an investor either buys or sells call and put options on the same underlying asset, both sharing the same strike price and expiration date. This allows the investor to potentially benefit from significant price changes.
With straddles in options trading, investors expect an asset’s price to move significantly, but they are unsure if it will move up or down in value. Thus, they take positions on both sides to capitalize on whichever way the asset moves.
Understanding Long Straddles
Long straddles involve buying call and put options on an asset with the same strike price and expiration date. The goal is for one of the two options positions to increase in value to offset the expense of the other. Investors risk losing the total premium paid for both options; this is the maximum loss so long as the asset’s price stays close to the strike price and neither option becomes profitable.
Let’s look at a hypothetical long straddle. An investor pays the same for a call contract as they do a put contract on the same asset. Both have the same strike. In order for the investor to break even, the stock must move enough in either direction to offset the combined premium cost.
If the asset’s price rises significantly, the call option can become profitable. If profitable enough, it can offset the cost of the premium of the put. The inverse is also true: if the asset’s value drops significantly, the put becomes profitable, and can offset the price of the call if it gains enough value. If the asset’s price remains close to the strike price, and neither the call nor the put options become profitable, the investor loses the entire premium paid for both options.
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Understanding Short Straddles
Short straddles are the opposite: investors sell both a call and put at the same time, profiting when the asset’s price stays close to the strike price. The goal is to benefit from minimal price movement, and to keep the premiums from both options. Unlike a long straddle, investors face unlimited risk if the asset moves significantly in either direction.
For example, let’s say an investor believes a stock is not likely to move during the length of an options contract. They may want to benefit from this anticipated inactivity by putting a short straddle in place, gaining the premium from selling their options on an asset that they don’t believe will move much outside the strike price.
If they’re right, they keep the premium. If not, they stand to lose significant amounts of money because they are required to fulfill their obligation whether that means buying or selling the asset above or below market price.
Understanding Long Strangles
In a long strangle, the investor buys calls and puts at different strike prices. The investor believes the stock is more likely to move up than down, or vice versa. In a short strangle, the investor sells a call and a put with different strike prices. The idea is to benefit from large price movements in either direction, and maximum loss is limited to the premiums paid.
Understanding Short Strangles
Short strangles are similar to long strangles, but involve selling rather than buying options. An investor sells both a call and a put option on the same asset with different strike prices, but the same expiration date.
The short strangle strategy looks to gain an advantage from low volatility, and the investor anticipates the asset’s price to stay between the strike prices of both options. Thus, the maximum profit is the total premium they receive from selling both options. If the asset’s price moves significantly beyond either strike price, however, the investor can face potentially unlimited losses, as they are obligated to buy or sell the asset at an unfavorable price.
Let’s say an investor sells a call and a put option on a stock with strike prices set above and below the current price. The investor does not foresee the stock price moving much outside the strike price. If the investor is right, and the stock stays between the two strike prices, they should be able to keep the premium. However, if the stock moves beyond either strike price, the investor faces potential losses as they must fulfill the option contracts at prices higher or lower than they may have expected.
7. Cash-Secured Puts
Level of Expertise: Intermediate
The cash-secured put strategy may generate income while positioning investors to potentially purchase a stock at a lower price than they might have through a simple market buy order.
With a cash-secured put, an investor writes a put option for a stock they do not own. The option has a strike price below the asset’s current trading level. The investor must have enough cash in their account to cover the cost of buying the 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 often employed when the investor has a bullish to neutral outlook on the underlying asset. If exercised, the option writer receives shares below market price while also holding onto the premium. Alternatively, if the stock trades sideways, the writer will still receive the premium without being obligated to purchase the shares.
8. Bull Put Spreads
Level of Expertise: Advanced
A bull put spread strategy 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 generate income from the premium received on the short put, as well as potentially from time decay. The maximum profit occurs if the stock price stays above the higher strike price at expiration, while the maximum loss occurs if the stock price falls below the lower strike price.
For example, a trader sells a put option with a higher strike price and buys a put option with a lower strike price, both on the same underlying asset. The maximum profit occurs if the stock price finishes above the higher strike price, making both options expire worthless. The maximum loss happens if the stock price falls below the lower put’s, as the trader incurs a net loss between the strikes, offset by the initial premium.
9. Iron Condors
Level of Expertise: Advanced
The iron condor consists of four option legs (two calls and two puts), and is designed to generate income in low-volatility environments through multiple options positions. Although the strategy has defined risk-reward limits, its potential for profit is small compared to the maximum possible loss if the asset price moves outside the defined range.
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 a call with a higher strike
4. Buy a call with an even higher out-of-the-money strike.
An iron condor strategy works best in low-volatility conditions. The trade profits from net premiums collected if the underlying asset stays between the short call and short put strike prices by expiration. These trades have defined risk and reward parameters. The maximum loss is limited to the difference between the long and short strikes, minus the net premium, while the maximum profit is limited to the net premium collected.
Let’s say an individual makes an iron condor on shares of a company that show signs of low volatility. The trader’s best case scenario for these positions would be for all the options to 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 collected from the trade.
10. Butterfly Spreads
Level of Expertise: Advanced
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 out-of-the-money call with a higher strike price.
The potential for maximum profit occurs if the stock reaches the middle strike price at expiration, since both short calls are exercised and the long calls no longer have intrinsic value. Maximum loss occurs when the stock price falls below the lower strike price, or if it rises above the higher strike price. Both would result in the loss of the total premium paid to open the position.
The Takeaway
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 unsuitable for some investors, but for experienced traders, these strategies can be worth considering.
Each strategy comes with its own set of risks and rewards — as well as the potential for losses. Ensure that your strategy of choice aligns with your market outlook, investing goals, and risk tolerance.
SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.
With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.
Explore SoFi’s user-friendly options trading platform.
🛈 SoFi does not offer naked options trading at this time.
Photo credit: iStock/Rockaa
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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.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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